EP2TB3 2023 Reference

London Market
insurance
essentials (EPA)
EP2: 2023 Study text
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2 EP2/October 2022 London Market insurance essentials (EPA)
© The Chartered Insurance Institute 2022

All rights reserved. Material included in this publication is copyright and may not be reproduced in whole or in part
including photocopying or recording, for any purpose without the written permission of the copyright holder. Such
written permission must also be obtained before any part of this publication is stored in a retrieval system of any
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Every attempt has been made to ensure the accuracy of this publication. However, no liability can be accepted for
any loss incurred in any way whatsoever by any person relying solely on the information contained within it. The
publication has been produced solely for the purpose of examination and should not be taken as definitive of the
legal position. Specific advice should always be obtained before undertaking any investments.
Print edition ISBN: 978 1 80002 595 0
Electronic edition ISBN: 978 1 80002 596 7
This edition published in 2022
The author
Charlotte Warr, LLB (Hons) FCII, Solicitor, Chartered Insurer, Senior Associate of the Association of
Average Adjusters.
Charlotte is a highly experienced claims adjuster with significant knowledge of both the Company and Lloyd’s
Markets as well as both marine and non-marine classes of business.
Charlotte has authored articles for technical journals and has spoken on a variety of insurance, legal and training
subjects around the world.
Acknowledgements
The CII gratefully acknowledges the contributions of technical reviewers Simon Penaluna, Terry Webb and Terry
Hayday to the production of previous editions of this text.
The CII would also like to thank the authors and reviewers of study texts IF1 and IF2, on which parts of this text rely.
The CII thanks the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) for their kind
permission to draw on material that is available from the FCA website: www.fca.org.uk (FCA Handbook:
www.handbook.fca.org.uk/handbook) and the PRA Rulebook site: www.prarulebook.co.uk and to include extracts
where appropriate. Where extracts appear, they do so without amendment. The FCA and PRA hold the copyright for
For reference only

all such material. Use of FCA or PRA material does not indicate any endorsement by the FCA or PRA of this
publication, or the material or views contained within it.
While every effort has been made to trace the owners of copyright material, we regret that this may not have been
possible in every instance and welcome any information that would enable us to do so.
Typesetting, page make-up and editorial services CII Learning Solutions.
Printed and collated in Great Britain.
This paper has been manufactured using raw materials harvested from certified sources or controlled wood
sources.
3
Using this study text

Welcome to the EP2: London Market insurance essentials (EPA) study text which is
designed to support the EP2 syllabus, a copy of which is included in the next section.
Please note that in order to create a logical and effective study path, the contents of this
study text do not necessarily mirror the order of the syllabus, which forms the basis of the
assessment. To assist you in your learning we have followed the syllabus with a table that
indicates where each syllabus learning outcome is covered in the study text. These are also
listed on the first page of each chapter.
Each chapter also has stated learning objectives to help you further assess your progress
in understanding the topics covered.
Contained within the study text are a number of features which we hope will enhance
your study:
Activities: reinforce learning through Key points: act as a memory jogger at

practical exercises. the end of each chapter.
Be aware: draws attention to important Key terms: introduce the key concepts
points or areas that may need further and specialist terms covered in each
clarification or consideration. chapter.
Case studies: short scenarios that will Refer to: Refer to: extracts from other CII study
test your understanding of what you texts, which provide valuable information
have read in a real life context. on or background to the topic. The
sections referred to are available for you
to view and download on RevisionMate.
For reference only

Consider this: stimulating thought Reinforce: encourages you to revisit a
around points made in the text for which point previously learned in the course to
there is no absolute right or wrong embed understanding.
answer.
Examples: provide practical illustrations Sources/quotations: cast further light

of points made in the text. on the subject from industry sources.
In-text questions: to test your recall of On the Web: introduce you to other
topics. information sources that help to
supplement the text.
At the end of every chapter there is also a set of self-test questions that you should use to
check your knowledge and understanding of what you have just studied. Compare your
answers with those given at the back of the book.
By referring back to the learning outcomes after you have completed your study of each
chapter and attempting the end of chapter self-test questions, you will be able to assess your
progress and identify any areas that you may need to revisit.
Not all features appear in every study text.
Note
Website references correct at the time of publication.
For reference only
5
Examination syllabus
London Market insurance

essentials (EPA)
Objective
To provide an essential grounding in the operation of the London insurance market.
Summary of learning outcomes Number of questions

in the examination*
1. Understand basic terminology used within the general insurance market 6
2. Understand the fundamental principles 10

of insurance
3. Understand the main classes of insurance written in the London Market 4
4. Understand the insurance cycle 1
5. Understand reinsurance within the insurance market 3
6. Understand the structure of the 5

London Market
For reference only

7. Understand the London Market regulatory and legal environment 10
8. Understand the importance of appropriate systems and controls 2
9. Understand data protection and money laundering legislation and requirements 2
10. Understand the broker’s role in the 4

way that business is conducted in the London Market
11. Understand the underwriter’s role in the way that business is conducted in the 3
London Market
* The test specification has an in-built element of flexibility. It is designed to be used as a guide for study and is not a statement of actual
number of questions that will appear in every exam. However, the number of questions testing each learning outcome will generally be within
the range plus or minus 2 of the number indicated.
Important notes
• Method of assessment: 50 multiple choice questions (MCQs). 1 hour is allowed for this
examination.
• This syllabus will be examined from 1 January 2023 until 31 December 2023.
• Candidates will be examined on the basis of English law and practice unless otherwise stated.
• This PDF document is accessible through screen reader attachments to your web browser and has
been designed to be read via the speechify extension available on Chrome. Speechify is an
extension that is available from https://speechify.com/. If for accessibility reasons you require this
document in an alternative format, please contact us on online.exams@cii.co.uk to discuss your
needs.
• Candidates should refer to the CII website for the latest information on changes to law and practice
and when they will be examined:
1. Visit www.cii.co.uk/qualifications
2. Select the appropriate qualification
3. Select your unit from the list provided
4. Select qualification update on the right hand side of the page
Published October 2022

©2022 The Chartered Insurance Institute. All rights reserved. EP2
1. Understand basic terminology used 7.3 Explain the governance of the Lloyd’s Market.
within the general insurance market 7.4 Examine and explain the role of the Financial
1.1 Explain the principle of good faith. Ombudsman Service and the Financial Services
Compensation Scheme.
1.2 Explain the meaning and application of proximate
cause. 7.5 Explain the basic powers of the industry regulator for
the authorisation, supervision and regulation
1.3 Describe the principle of indemnity and how it is
of insurers.
modified.
7.6 Explain the basic powers of the industry regulator for
1.4 Explain the concept of contribution and how it is
the authorisation, supervision and regulation of
applied.
insurance intermediaries.
1.5 Explain what is meant by subrogation.
7.7 Describe the essentials of a valid contract of
insurance
2. Understand the fundamental principles
of insurance 8. Understand the importance of
2.1 Describe the concept of risk. appropriate systems and controls
2.2 Explain the categories of risk. 8.1 Explain the purpose of sanctions.
2.3 Explain the principle of the pooling of risks. 8.2 Examine and describe the basic systems and
2.4 Explain the difference between a peril and a hazard controls to ensure adherence to EU, US and UK
as this relates to insurance. legislation.
2.5 Explain what moral and physical hazard is and
identify good and poor examples of each. 9. Understand data protection and money
2.6 List the types of insurable and uninsurable risks.
laundering legislation and requirements
9.1 Explain the principles, rights and restrictions of data
2.7 Explain the basic purpose of insurance.
protection legislation and its impact on transacting
2.8 Explain the primary and secondary functions of business.
insurance.
9.2 Explain the various requirements to ensure money
For reference only

2.9 Explain the importance of the claims handling laundering compliance when dealing with clients.
process.
10. Understand the broker’s role in the
3. Understand the main classes of way that business is conducted in the
insurance written in the London Market London Market
3.1 Describe the main classes of insurance written in the 10.1 Explain the role and responsibilities of brokers.
London Market and their main features.
10.2 Explain the business process of broking and the
4. Understand the insurance cycle parties involved.
4.1 Outline and explain the insurance cycle. 10.3 Explain the broker’s role in the handling of
premiums.
5. Understand reinsurance within the 10.4 Explain the broker’s role in claims notification,
insurance market investigation and settlement.
5.1 Explain the purpose of reinsurance.
11. Understand the underwriter’s role in the
5.2 Describe the main terminology used in connection
with reinsurance transactions and know their
way that business is conducted in the
meaning. London Market
11.1 Explain the role and responsibilities of underwriters.
6. Understand the structure of the 11.2 Explain the role and responsibilities of the lead and
London Market following underwriters within the London Market.
6.1 Describe the main participants in the London Market
and the implications of their participation.
6.2 Explain the importance of the London Market and
why clients may decide to place their business within
this market.
6.3 Explain the role of the London Market associations.
6.4 Explain the way that business is transacted in the
London Market.
7. Understand the London Market regulatory

and legal environment
7.1 Describe the role, aims, approach to regulation; and
principles for business of the industry regulator.
7.2 Describe the role of major international regulators,
including licensing.
Published October 2022 2 of 3

©2022 The Chartered Insurance Institute. All rights reserved.
7
Reading list Exam technique/study skills

There are many modestly priced guides
The following list provides details of further
reading which may assist you with your available in bookshops. You should choose
studies. one which suits your requirements.
Note: The examination will test the
syllabus alone.
The reading list is provided for guidance
only and is not in itself the subject of the
examination.
The resources listed here will help you
keep up-to-date with developments and
provide a wider coverage of syllabus topics.
CII study texts

London Market insurance essentials (EPA).
London: CII. Study text EP2.
Books and eBooks
Bird’s modern insurance law. 10th ed. John
Birds. Sweet and Maxwell, 2016.
Insurance theory and practice. Rob Thoyts.
Routledge, 2010.*
Lloyd’s: law and practice. 2nd ed. Julian
For reference only

Burling. Oxon: Informa Law, 2017.*
Periodicals
The Journal. London: CII. Six issues a year.
Market magazine. Lloyd's of London.
Quarterly.
Post magazine. London: Incisive Financial
Publishing. Monthly. Contents searchable
online at www.postonline.co.uk.
Reference materials
Concise encyclopedia of insurance terms.
Laurence S. Silver, et al. New York:
Routledge, 2010.*
Dictionary of insurance. C Bennett. 2nd ed.
London: Pearson Education, 2004.
Examination guide
If you have a current study text enrolment,
the current examination guide is included
and is accessible via Revisionmate
(ciigroup.org/login). Details of how to access
Revisionmate are on the first page of your
study text. It is recommended that you only
study from the most recent version of the
examination guide.
* Also available as an eBook through eLibrary via www.cii.co.uk/elibrary (CII/PFS members only).
Published October 2022 3 of 3

©2022 The Chartered Insurance Institute. All rights reserved.
For reference only
9
EP2 syllabus
quick-reference guide
Syllabus learning outcome Study text chapter
and section
1. Understand basic terminology used within the general insurance market
1.1 Explain the principle of good faith. 2D
1.2 Explain the meaning and application of proximate cause. 2F
1.3 Describe the principle of indemnity and how it is modified. 2G
1.4 Explain the concept of contribution and how it is applied. 2H
1.5 Explain what is meant by subrogation. 2I
2. Understand the fundamental principles
of insurance
2.1 Describe the concept of risk. 1A, 1B, 1C
2.2 Explain the categories of risk. 1D
2.3 Explain the principle of the pooling of risks. 1F
2.4 Explain the difference between a peril and a hazard as this 1C
relates to insurance.
2.5 Explain what moral and physical hazard is and identify good and 1C
poor examples of each.
For reference only

2.6 List the types of insurable and uninsurable risks. 1E
2.7 Explain the basic purpose of insurance. 1G
2.8 Explain the primary and secondary functions of insurance. 1H, 1I
2.9 Explain the importance of the claims handling process. 1J
3. Understand the main classes of insurance written in the London Market
3.1 Describe the main classes of insurance written in the London 3A, 3B, 3C
Market and their main features.
4. Understand the insurance cycle
4.1 Outline and explain the insurance cycle. 4A, 4B, 4C
5. Understand reinsurance within the insurance market
5.1 Explain the purpose of reinsurance. 3D
5.2 Describe the main terminology used in connection with 3D
reinsurance transactions and know their meaning.
6. Understand the structure of the
London Market
6.1 Describe the main participants in the London Market and the 5A, 5B, 5C, 5D, 5E
implications of their participation.
6.2 Explain the importance of the London Market and 5E, 5G
why clients may decide to place their business within this market.
6.3 Explain the role of the London Market associations. 5F
6.4 Explain the way that business is transacted in the 5G, 8D, 8E, 9C
London Market.
7. Understand the London Market regulatory and legal environment
7.1 Describe the role, aims, approach to regulation; and principles 6A, 6B
for business of the industry regulator.
7.2 Describe the role of major international regulators, including 6C
licensing.
7.3 Explain the governance of the Lloyd’s Market. 6D
Syllabus learning outcome Study text chapter

and section
7.4 Examine and explain the role of the Financial Ombudsman 6F
Service and the Financial Services Compensation Scheme.
7.5 Explain the basic powers of the industry regulator for the 6E
authorisation, supervision and regulation
of insurers.
7.6 Explain the basic powers of the industry regulator for the 8B
authorisation, supervision and regulation of insurance
intermediaries.
7.7 Describe the essentials of a valid contract of insurance 2A, 2B, 2C, 2E
8. Understand the importance of appropriate systems and controls
8.1 Explain the purpose of sanctions. 7B
8.2 Examine and describe the basic systems and controls to ensure 7A, 7E
adherence to EU, US and UK legislation.
9. Understand data protection and money laundering legislation and requirements
9.1 Explain the principles, rights and restrictions of data protection 7C
legislation and its impact on transacting business.
9.2 Explain the various requirements to ensure money laundering 7D
compliance when dealing with clients.
10. Understand the broker’s role in the
way that business is conducted in the London Market
10.1 Explain the role and responsibilities of brokers. 8A
10.2 Explain the business process of broking and the 8C, 8D
For reference only

parties involved.
10.3 Explain the broker’s role in the handling of premiums. 8D
10.4 Explain the broker’s role in claims notification, investigation and 8E
settlement.
11. Understand the underwriter’s role in the way that business is conducted in the London
Market
11.1 Explain the role and responsibilities of underwriters. 9A, 9B
11.2 Explain the role and responsibilities of the lead and following 9C
underwriters within the London Market.
11
Introduction
EP2: London Market insurance essentials (EPA) starts the student on their learning journey
within the London Market and is the first unit in both the Award in London Market Insurance
and Certificate in Insurance (London Market).
It begins by introducing fundamental principles of insurance and risk as well as the reasons
for buying and selling insurance. It will consider the challenges presented to the marketplace
as a whole by the pandemic as well as the opportunities that it might also present.
Your study text will also discuss the function of insurance within the wider economy and its
further role to protect citizens.
Legal principles and terminology are also introduced as well as the main classes of business
written in the London Market and the theory of the insurance business cycle.
The structure of the London Market is looked at in some detail to identify the various players
and the flow of business around the market. The regulatory framework is also introduced and
an overview is given of both national and international regulation as it might apply to both
brokers and insurers operating in the London Market.
Finally, the unit will give the student a firm understanding of the role of the broker and
underwriter within the wider context of the market. Some of the concepts outlined within this
unit will be built on in more detail within unit LM2: London Market insurance principles and
practices, and encourage all students to better understand their role within the marketplace
and how it operates around them.
For reference only

For reference only
13
Contents
1: Fundamental principles of insurance
A Concept of risk and risk transfer 1/2
B Risk management 1/4
C Components of risk 1/8
D Categories of risk 1/12
E Features of insurable risks 1/14
F Pooling of risk 1/16
G Reasons for buying insurance 1/17
H Primary and secondary functions of insurance 1/17
I Compulsory insurance 1/18
J The claims handling process 1/21
2: Basic insurance legal principles and terminology

A Contract law 2/2
B Consideration 2/5
C Insurable interest 2/6
For reference only

D Duties of disclosure during contract negotiation 2/8
E Cancellation of insurance contracts 2/17
F Proximate cause 2/18
G Indemnity 2/21
H Contribution 2/31
I Subrogation 2/34
3: Main classes of business written in the London Market

A Marine insurance 3/2
B Non-marine insurance 3/11
C Aviation insurance 3/21
D Reinsurance 3/22
4: The insurance cycle

A Supply and demand 4/2
B Supply and demand in the insurance marketplace 4/5
C Reasons why the insurance cycle might vary 4/8
5: Structure of the London Market

A Lloyd’s Market 5/2
B Company market 5/8
C Brokers 5/10
D Managing general agents 5/10
E International aspects of the London Market 5/10
F Market associations 5/11
G Flow of business in the London Market 5/14
6: Legal and regulatory environment

A Overview of the UK regulatory framework 6/2
B Operation of the FCA and PRA 6/3
C Overseas regulation 6/12
D Lloyd’s Market governance 6/16
E Authorisation of new insurers 6/19
F The Financial Ombudsman Service (FOS) and Financial Services 6/22
Compensation Scheme (FSCS)
7: Regulatory processes, systems and controls
For reference only

A Impact of UK, EU and US regulation 7/2
B Sanctions 7/5
C Data protection 7/10
D Anti-money laundering 7/14
E Bribery 7/19
8: Role of a broker
A Legal basis of the broker’s role 8/2
B Regulation 8/7
C Services provided by intermediaries 8/9
D Broker’s role in the placing process 8/10
E Broker’s role in the claims process 8/14
9: Underwriters
A Role of an underwriter 9/2
B Functions of an underwriter 9/2
C Subscription market 9/2
Self-test answers i
Cases xi
Legislation xiii
Index xv
Chapter 1
Fundamental principles
1
of insurance
Contents Syllabus learning
outcomes
Introduction
A Concept of risk and risk transfer 2.1
B Risk management 2.1
C Components of risk 2.1
D Categories of risk 2.2
E Features of insurable risks 2.6
F Pooling of risk 2.3
G Reasons for buying insurance 2.7
For reference only

H Primary and secondary functions of insurance 2.8
I Compulsory insurance 2.8
J The claims handling process 2.9
Key points
Question answers
Self-test questions
Learning objectives
After studying this chapter, you should be able to:
• describe the concept of risk and risk transfer;
• explain the components of risk and the concept of risk management;
• explain the categories of risk and those that can be insured;
• explain the pooling of risk;
• explain the difference between peril and hazard and give examples;
• explain the basic purpose of insurance and the reasons for its purchase;
• list the various types of compulsory insurance; and
• explain the importance of the claims handling process.
Chapter 1 1/2 EP2/October 2022 London Market insurance essentials (EPA)
Introduction
We start our studies by exploring the concept of risk and the various ways in which this word
is used within the insurance business. We will look at the different types of risk and which are
insurable, together with the things that enhance the risk itself.
In this first chapter, we will also look at the types of insurance that are compulsory, and the
purposes and functions of insurance.
Key terms
This chapter features explanations of the following terms:
Financial risks Fortuitous event Frequency Fundamental risks

Hazard Homogeneous Insurable interest Non-financial risks
exposures
Particular risks Peril Pooling of risk Pure risks
Risk Risk transfer Severity Speculative risks
Uncertainty
A Concept of risk and risk transfer

The word ‘risk’ is used in many different ways in the insurance marketplace and we need to
look at each of these in turn. Here we will examine the term in its everyday sense and find
our first problem. There is no universally recognised definition for the term risk.
For reference only

A1 Risk perception
If you were to ask anyone what the term ‘risk’ means to them you are likely to receive a wide
variety of answers – everything from the owner of the business being concerned about the
possibility of recession to worried parents concerned about all kinds of dangers faced by
their children. Yet others may identify the risks inherent in running a business – perhaps the
demand for their products or obsolescence issues. The list of risks that we face in everyday
life is almost endless.
In a personal sense, we all take decisions based upon an assessment of risk, albeit that it is
usually carried out informally. We assess the likelihood of rain occurring and decide whether
to take an umbrella when we leave home in the morning. There may be some data involved
(a weather forecast) or we may have merely looked out of the window to make a judgment
about the likelihood of rain. This informality may be acceptable in 'low risk' situations where
the ultimate calamity is something like wet clothing, but in many contexts, we need better
measurement tools, especially where the potential for loss is significant.
Risk measurement and the means of attempting to deal with the risks we face are
collectively termed risk management. In a commercial context, this is often a well-defined
and scientific process, attempting to answer questions such as ‘How much will it cost if
things go wrong?’ and ‘What are the chances of the risk becoming a reality?’ We will deal
with these issues in greater detail later in the study text. In a personal sense, most
individuals make less precise calculations, often preferring instead simply to protect against
those things that seem capable of inflicting some kind of financial disaster, such as fire
or theft.
We begin by considering just what is meant by the term ‘risk’.
Chapter 1 Fundamental principles of insurance 1/3
Chapter 1
A2 Definition of risk
Consider the following statements, each giving a different slant to the term ‘risk’:
• possibility of something unfortunate happening;
• doubt concerning how something will turn out;
• unpredictability;
• possibility of a loss; and
• chance that there might be a gain (the horse you backed might win).
Refer to
Types of risk that can be insured are covered in Features of insurable risks on page 1/14
Whichever choice we make (umbrella or no umbrella for example), we need to recognise the
elements of uncertainty and unpredictability or, in some cases, danger. The term often
implies something that we do not want to happen.
Consider for example the many risks associated with owning a building. These include the
risk that:
• the building might be damaged by fire or flood;
• someone working in or visiting the building might get injured; or
• someone else’s property might get damaged either by parts of the building falling on it or
whilst being stored in the building.
Each of these represents a risk so far as the owner is concerned and in each case it is
possible to insure (transfer) the risk. This is done by the owner paying a known premium to
an insurer in return for the insurer accepting the future unknown cost of the insured risk. The
For reference only

insurer does this by promising to pay for loss, damage or liability as defined by the policy
terms. Insurance, therefore, is a means of transferring the risk.
The acceptance of an unknown future potential risk by an insurer for an agreed premium is a
way of defining insurance as a risk transfer mechanism. It brings peace of mind to the
insured because they have replaced the uncertainty of possible future loss with the certainty
of the agreed premium. We consider this aspect later in the chapter in Reasons for buying
insurance on page 1/17.
Activity
If you were the owner of the building in which your office is located, consider all the bad
things that could happen – what might go wrong?
A3 Other meanings of the term ‘risk’

There are three other ways in which the term is used in the insurance marketplace:
• peril being insured (e.g. fire or collision);
• subject-matter of insurance (e.g. the factory, ship or potential liability); and
• the thing insured, such as the property itself, and the range of contingencies or scope of
cover required (if the term is used by an insurer, they often mean both of these).
A4 Attitude to risk
Each person’s attitude to risk is different. Therefore, we all respond to risk in a different way.
Some people are willing to carry certain risks themselves and are termed risk-seeking,
while others lean more towards being risk-averse, feeling happier minimising the risk to
which they are exposed (perhaps by transferring the risk by means of insurance – see
Reasons for buying insurance on page 1/17). Very few individuals are in a position to
evaluate, with any accuracy, the risks to which they are exposed. However, many companies
attempt to achieve this as part of their risk management process.
Consider this…
What is your personal view of risk – do you consider yourself to be risk-averse or risk-
seeking? Will you go out without an umbrella?
Does your view change if the risk involves any potential financial loss aspects?
Question 1.1
Which of these terms describes an individual who is keen to remove risk where
possible?
a. Risk unhappy. □
b. Risk-averse. □
c. Risk-seeking. □
d. Risk confident. □
B Risk management
There is a continuing trend towards taking control and developing a formal strategy for
managing the various risks that affect businesses. The appointment of risk managers in
industry and commerce is now commonplace. Many are members of the Association of
Insurance Risk Managers. This organisation shortened its name by the omission of the
words 'in Industry and Commerce' but has kept its old acronym of AIRMIC.
For reference only

On the Web
www.airmic.com
Risk management is important for a number of reasons:
It reduces the It gives shareholders It provides a

potential for loss confidence that the disciplined
business is being approach to
run properly* quantifying risk
Be aware
* For companies quoted on the stock market there is a legal requirement to identify all
significant risks to which the business is exposed and to explain in the annual report how
these are being managed.
The decision to transfer risks (for example, by insurance) is an important final stage in the
risk management process.
When it comes to general insurance, risk management is a significantly different concept for
individuals than it is for businesses. Many individuals, when they consider their own financial
planning, personal protection and wealth management issues, tend to adopt a formalised
approach – often facilitated by a financial adviser. The decision-making process involves the
completion of a detailed ‘fact-find’ and an equally detailed consideration of their income,
savings, assets, health and future aspirations.
However, the issue of personal general insurance does not very often follow this detailed
process. Often it is not bought as the result of a carefully made decision that insurance is the
best solution to a particular financial problem. Instead, it is bought because certain elements
of cover may be compulsory, such as third party motor insurance, which the law requires
everyone to have (see Compulsory insurance on page 1/18 for more information).
Alternatively, it may be that another party has a financial interest in the item to be insured; for
Chapter 1
example, a homeowner’s mortgagee (such as a bank) who will insist upon insurance being
effected.
Of course, there are areas where there is real choice as to whether to insure or manage the
risk in some other way. However, even here it is highly unlikely that a scientific approach will
be taken to assessing risk. The most dominant factor is likely to be an individual’s risk
appetite or an inability to afford insurance protection.
Individuals with very substantial physical assets may adopt a more formalised system. These
types of policyholders are often termed ‘high net worth’ individuals and certain insurance
products have been developed specifically for them.
Activity
Conduct a poll of your colleagues, family or friends in relation to their motor insurance.
How many of them have fully comprehensive insurance as opposed to the legal minimum
of third party insurance? Ask them why they have more insurance than the law requires
and how they came to make their purchasing decision.
Is there any pattern in their answers?
B1 Function of risk management

Risk management may be defined as: ‘The identification, analysis and economic control
of those risks which can threaten the assets or earning capacity of an enterprise.’
The focus of good risk management is the identification and treatment of defined risks. Risk
management should be a continuous and developing process embedded in a firm’s strategy.
It should address methodically all the risks surrounding the firm’s current, past and future
activities. This definition identifies the three steps involved in managing the risk, namely:
For reference only

identification analysis control
Let us look at these in more detail. Think of risk as the bad things that could happen.
B1A Risk identification
This step involves the company discovering its possible existing and potential future threats.
Not all of these risks will be insurable, but they must all be managed.
For example, in the case of a retail shop, petty theft and shoplifting may be real risks and will
need to be managed in some way or funding set aside to cover their costs.
For many conventional risks, such as a factory owner looking for physical damage insurance
for their buildings, an insurer may become involved in helping to identify existing and
potential risks through carrying out a physical examination or survey. Insurers also play a
role in relation to risk control when they provide reports following the survey. Even if the risk
is not ultimately insured, the client still has the benefit of the insurer’s advice concerning
the risk.
B1B Risk analysis
Risk managers examine past data to evaluate or analyse the risk. For example, they can
look at the past loss patterns of, say, hurricanes on the east coast of the USA, and so predict
likely losses in the future.
Insurers will look at many of the same elements when considering the rating of a risk.
B1C Risk control

If the risk is seen to have the potential for adverse consequences, some course of action
should be put in place to control, reduce or even eliminate the risk. Elimination is the most
effective, but may be costly or impracticable.
For example, if a manufacturer carries out some paint-spraying. This activity has the
following risks (not a complete list):
• Spraying other items because the area has not been sealed and the paint has moved in
the wind perhaps onto other people’s property.
• Employees becoming ill because they have breathed in paint vapours.
The manufacturer has the choice not to perform the process altogether and in so doing
eliminate that element of the risk.
Alternatively, they can analyse, assess and manage the risk to prevent or minimise the
occurrence of any adverse things.
This analysis should consider:
• First, what is the likelihood of the risk actually happening – using, for example, a scale of
1–3, with 3 being the most likely.
• Secondly, considering the likely impact on the same scale of 1–3.
These two numbers can then be multiplied allowing the business to rank in order the risks it
faces. This allows the business to undertake any analysis of the costs of minimising or
mitigating losses.
A typical cost cost-based analysis using our scenario above is, for example, how much does
it cost to enclose entirely the spraying area to prevent over-spray? Is the multiplier of
likelihood X impact serious enough to warrant this expense? Does it make more practical
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sense to have the spraying done by another organisation?
The elimination of risk, or even its reduction, will always be subject to the test of whether the
cost of doing so is reasonable compared to the cost of the feared event happening.
There are
two distinct
aspects to the
controlling of
risk:
financial controls such

as making sure that
physical controls such contracts are well-worded
as installing sprinklers (e.g. arranging for a
and alarm systems security firm to accept
responsibility for cash
whilst in its control)
Insurers (and to an increasing degree, insurance brokers) assist in the area of loss
prevention and control. They do so by imposing requirements and making recommendations
designed to improve the risk, following the completion of a survey. These are important parts
of the pre-risk surveyor’s report and are aimed at either improving the risk to an acceptable
standard from the insurer’s point of view, or offer premium reduction as an incentive for
worthwhile risk improvements.
In a wider context, insurers are involved in researching areas of loss prevention and control
through their work with organisations such as the Building Research Establishment (BRE)
and the Fire Protection Association (FPA).
Chapter 1
providing
construction
guidelines
The type
of work that
these bodies
undertake
includes:
providing
researching new
reports on new
construction
industrial
methods
processes
Insurers must strive constantly to ensure that their knowledge of their potential clients’
businesses remains up-to-date, whether that is in relation to new types of building
construction, the further development of offshore drilling technology or the law changing so
as to extend potential liabilities.
Activity
For reference only

Think about how building construction has changed in the last few years – look around
you and see the different materials that are going into modern building construction. How
do you think this affects the risks presented by clients to insurers?
Use this link to access guidance provided by the Fire Protection Association: https://
www.thefpa.co.uk/news/fire-safety-advice-and-guidance.
Question 1.2
A factory installing sprinklers into its premises is an example of which activity?
a. Risk transfer. □
b. Risk modelling. □
c. Risk control. □
d. Risk analysis. □
C Components of risk
In order to gain a deeper understanding of the meaning of risk, we need to take a closer look
at the various components of risk.
These include:
uncertainty level of risk peril and hazard
C1 Uncertainty
The concept of uncertainty implies doubt about the future, as a result of our incomplete
ability to predict what is going to happen. If we could say with certainty what was going to
happen, there would be no element of risk involved. If we know that our factory will burn
down at 4pm tomorrow, or that on the way home we will have a car accident, there is no risk
of the event happening, as the event would become a certainty. As we do not have this prior
knowledge, we can say that we live in an uncertain or risky environment and that risk exists
separately from the individual.
Even in the context of life insurance there is uncertainty. We know that we will all die one day
but we do not know when.
C2 Level of risk
The second aspect of risk relates to the different levels of risk that exist. We know that there
is a greater likelihood of some things happening than others and this is what we mean by the
level of risk involved.
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Risk is usually assessed in terms of:
• frequency – how often it will happen; and
• severity – how serious it will be if it does happen.
These are the measurement criteria used in the risk management process.
Example 1.1
Frequency
Imagine a building situated by the side of a river which is known to be prone to overflowing
its banks. This situation involves risk. There is some doubt as to the future outcome
because it is uncertain whether the river will ever overflow and (if it does) when this will
happen. The fact that the river is prone to overflowing increases the chance that damage
will occur.
Imagine a second building which is 100 metres away from the riverbank and on a slight
hill. This building will be less at risk from flooding because of its position.
Example 1.2
Severity
Our judgment as to the level of risk posed may change if we consider the potential amount
of loss, damage or destruction. For example, if the first building close to the river is valued
at £90,000 and the second building, further away, is valued at £250,000, we might modify
our view as to which building represents the higher risk, in view of the higher potential
severity of loss.
Consider this…
What is your common sense view of which building is potentially safer from the
flooding risk?
Chapter 1
Therefore, factors relating to both frequency and severity must be taken into account in our
assessment of risk. The relationship between frequency and severity varies from one risk to
another.
High frequency and low severity
An example of high frequency and low severity of loss could be comprehensive private motor
insurance, where there are many losses for damage to the insured's own vehicle which are
low in value, but relatively few third party personal injury claims which will be far higher
in value.
Figure 1.1: The relationship between severity and frequency
Frequency
Severity B
Low frequency and high severity

In this case, a small number of events would result in very high costs. Accidents involving
aircraft are good examples of this type of risk profile because, when a loss occurs, the cost
could be substantial. However, technological advance helps to reduce the frequency of
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accidents.
Activity
Look at this page from the CAA website and see how the aviation industry is trying to
understand and control risk and hazard.
bit.ly/2NuttPa.
Significance of frequency and severity

The different frequency and severity profiles are important to insurers. This is because they
wish their businesses to be, as far as possible, free from great peaks and troughs in relation
to claim payments made from one year to the next. Smooth trends in trading patterns tend to
encourage investors to support an insurer.
An insurer often bases its decisions on how much of a risk it can prudently accept on factors
relating to frequency and severity. Insurers have various ways of dealing with a risk that is
offered to them where the amount involved exceeds their normal acceptance limits. We will
review this further in Reinsurance on page 3/22.
A key reason for an insurer to be able to predict the frequency and severity of losses is to
forward plan in order to be able to respond to infrequent large catastrophe-type claims. It is
also important that an insurer can calculate its financial exposure to risks; this subject is
reviewed further in study text LM2: London Market insurance principles and practice.
The potential for a particular risk to occur (frequency) can be graded on a scale (for example,
1–3 where 1 indicates a small likelihood and 3 is a higher likelihood). The likely impact if that
risk were to occur (severity) can also be graded (using the same scale of 1–3). By
multiplying the two numbers together a final grading for any risk can be obtained, which then
allows risk managers to consider where to concentrate their efforts on control, management
and mitigation.
Activity
Try and find a copy of your company’s risk register and see which risks are listed and their
relative grading.
Question 1.3
An aviation insurer does not expect many losses in a year but knows that they are
likely to be of a high value when they do occur. Which of these describes this pattern
of losses?
a. High frequency and high severity. □
b. Low frequency and high severity. □
c. High frequency and low severity. □
d. Low frequency and low severity. □
C3 Peril and hazard
Let's start with a brief definition for both peril and hazard.
Peril can be defined as that which gives rise to a loss, i.e. fire or flood.
Hazard can be defined as that which influences the operation or effect of the peril.
Consider this…
Consider a factory insured against fire which has no sprinklers installed.
If a fire breaks out – that is the peril. The lack of sprinklers is a hazard in this scenario as
it has the potential to make the fire cause more damage than it otherwise would.
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Here are some other examples of peril:
Explosion this is the event insured against, which may give rise to loss.
Lightning when it occurs, this natural peril can result in damage.
Collision whether between ships, aircraft, or vehicles.
Dishonesty either employees or external parties stealing from a company for example.
C3A Physical and moral hazard

Physical hazard relates to the physical characteristics of the risk and includes any
measurable dimension of the risk. Examples include the following:
Security protection the greater the security protection, the better the physical hazard.
at a shop
The construction of the higher the standard of building construction the less likely it is that it will suffer damage.
the property These standards can apply to both the materials used and the building process itself.
Age of a proposer these are factual, measurable dimensions.

and type of car for
motor insurance
Moral hazard arises from the attitude and behaviour of people. In insurance, this is usually
the conduct of the insured. Moral hazard also arises from the conduct of the insured’s
employees and that of society as a whole.
Chapter 1
For example:
Carelessness a driver’s lack of care can increase the chance of an accident happening and its severity.
Dishonesty a person who has previously made fraudulent or exaggerated claims represents a poor
moral hazard.
Social attitudes a person who regards insurance fraud as acceptable and not immoral.
The way in which a business is run is also an example of moral hazard. For example,
careless or lax management in a factory represents poor moral hazard. This is clearly
something relating to attitude and behaviour, but it may be evident because of unguarded
machinery or a lack of control of smoking by employees, for example.
It is unsafe to jump to the conclusion that there is an adverse moral aspect to a risk, merely
because the risk is an obviously heavy one. For example, a fireworks factory represents a
very heavy fire risk, but it does not follow that there is a poor moral aspect to the risk. The
safety and security within the factory may be world class, and therefore the hazard is low
and mitigates the apparent size of the risk.
Equally, a young driver who is driving a high-performance car certainly represents a poor
moral hazard on the face of it as the statistics show that a large proportion of car accidents
are caused by young drivers. The car itself will be in a high rating group because of its value
and performance. These two aspects are physical because they are measurable. It is, of
course, important to factor into the equation other key information such as the proposer’s
loss history and any serious motoring convictions.
Looking again at some of the perils identified above, some of the hazards which can be
linked with them are:
Explosion this is the event insured against, which may give rise to loss. The hazards that might be
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linked with this are the storage of dangerous chemicals or not ensuring that there is no
smoking in certain areas.
Lightning when it occurs, this natural peril can result in damage. Hazards would be the construction
of any buildings struck by the lightning or the inadequacy of any lightning conductors
being used.
Collision whether between ships, aircraft, or vehicles. The hazards are in relation to speed,
behaviour, extent of training for example. Having a relaxed attitude to the speed limit as a
driver is an example of bad moral hazard.
Dishonesty either employees or external parties stealing from a company for example. The hazards
are things like poor security in place or inadequate operational controls. A lax corporate
attitude to security is an example of bad moral hazard.
Question 1.4
A factory manufacturing fireworks is inspected by insurers and found to have
excellent safety protocols and good training for the staff. What are the protocols and
training examples of?
a. Good moral hazard. □
b. Poor moral hazard. □
c. Good physical hazard. □
d. Poor physical hazard. □
D Categories of risk
Not every type of risk or eventuality is insurable. It will help our understanding if we look at
(and contrast) different types of risk to identify those that are insurable and those that are
not. The groupings that we will look at are:
• financial and non-financial risks;
• pure and speculative risks; and
• particular and fundamental risks.
D1 Financial and non-financial risks

Some of the risks that we face are not capable of financial measurement. They may have a
financial aspect to them, but it is incidental. The real risk arises from decisions and actions
motivated by other considerations. Take for example the choice of a marriage partner or our
enjoyment of a holiday.
We cannot measure these in financial terms. In the same way, the value we might place on
an heirloom that has been in the family for years, may be far beyond its intrinsic or market
value. Insurance is not appropriate for such risks. The heirloom could indeed be insured but
only for its market value, not for the sentimental value we place on it.
For a risk to be insurable the outcome of adverse events must be capable of measurement
in financial terms. Most general insurances are compensatory in nature – this means that the
value placed on the loss is not determined in advance.
Important exceptions to this general rule are personal accident and sickness policies that we
will touch on in chapter 2. This is because there is no way of valuing precisely the loss of a
life or the loss of sight so these policies are taken out in order to provide pre-agreed amounts
in the event of an accident or sickness and are known as benefit policies. Similar
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considerations apply to life insurance policies.
Let us look at some examples of financial risks to help us understand this concept.
Loss What is insurable?
Accidental damage to a The financial value of the risk is the cost of repairing or replacing the vehicle.
motor car
Theft of property The financial value of the risk of theft of an item of jewellery is its current market
value. This is measurable in financial terms. It would not include sentimental value
because, as we have seen, this is not precisely measurable in financial terms.
Loss of business profits This risk is measurable since comparisons can be made to similar trading periods to
following a fire devise a fair estimate of the loss to be paid by the insurer as compensation.
Legal liability to pay The courts measure the value of damages applicable for the loss of a leg, for
compensation for example, against compensation payments made previously by the courts. The courts
personal injury to others calculate damages that will take account of financial circumstances as well as the
injury itself, for example covered future medical payments or special equipment.
D2 Pure and speculative risks

There are many situations in life when we speculate with a view to making some kind
of gain.
Obvious examples are the National Lottery or other forms of gambling. There are also
situations such as investing in the stock market or starting up a new business that fall into
this category, as well as pricing decisions and other aspects of marketing. With each activity
we aim to make a gain, but each carries the possibility of break-even or failure.
Consequently, although there are some aspects of business activity that can be insured, this
does not include things such as misreading the market or a business failing because of local
competition. These are called speculative risks and they cannot be insured.
Pure risks, on the other hand, are those where there is the possibility of a loss but not of
gain, and where the best that we can achieve is a break-even situation. Travelling in an
aircraft is a good example. The best that we can hope for is a safe arrival. The possibility
exists however, that there might be an accident and the aircraft damaged or someone
injured. It is these types of risk that are generally insurable.
Chapter 1
You may have already thought of these, but here are some examples of pure risks.
Pure risk Information
Risk of fire This could damage or destroy property or cause an interruption to the running of the
business, both risks are measurable in financial terms.
Risk of machinery This could lead to actual damage or business interruption and is measurable in
breakdown financial terms.
Risk of injury to If such injury is caused by the negligence of the company, a court may award
employees at work damages and costs. These risks are measurable in financial terms.
Consider this…
If you decide to abandon your career in insurance and become a fashion designer – you
can insure the pure risks associated with your workshop and equipment, but you cannot
insure against the risk of your first collection being a disaster – this would be
speculative risk.
D3 Particular and fundamental risks

There are some risks that occur on such a vast scale that they are uninsurable. These are
called fundamental risks. Take for example the risk of famine or economic recession.
Fundamental risks can be defined as those that arise from social, economic, political or
natural causes and are widespread in their effect. As we have seen, non-financial or
speculative risks are uninsurable as a matter of principle.
In contrast, the problem with fundamental risks is that it is often a lack of appetite or capacity
on the part of insurers that causes such risks to be difficult to insure or even completely
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uninsurable. An example of this would be the risk of war.
It is not an easily defined category and there seem to be, on the face of it, many exceptions
to the general rule, particularly in the London Market. Just think of the fact that marine
insurers will often grant war risks cover for vessels and cargo, or even the fact it is possible
to be insured for earthquake cover in California. Nevertheless, the fact remains that those
risks that tend to affect whole countries, regions or communities are classified as
fundamental and therefore generally difficult to obtain insurance for in the commercial
market.
Fundamental risks
Two risks automatically categorised in this way for non-marine policies are war risks and
nuclear risks.
Reinforce
Think about some of the widespread natural disasters, wars and economic recessions of
the past 15 years. What might the claims impact have been on the insurance industry?
Activity
Visit the Sigma website: www.swissre.com/sigma.
Locate and read the latest report concerning catastrophe losses and see how many of
them might fall into this category of fundamental risk. How many of the catastrophes listed
was your organisation involved with?
Unlike fundamental risks, particular risks are localised or even personal in their cause and
effect. Sometimes the cause may be more widespread (a storm over a whole region), but the
effect is localised or even related to an individual. For example, not all properties in the
region will have been damaged.
Let’s look at some examples of particular risks.
Particular risk Information
Factory fire This would cause localised damage to the factory and possibly to its surroundings,
but would not affect the whole community.
Car collision Damage to the vehicles and any third party liability are localised events affecting
relatively few individuals.
Theft of personal An event that only affects an individual or family.

possessions
from a home
We have established that only certain classifications of risk are insurable: those that are
financial, pure and particular. There are certain other things that need to be in place for a risk
to be insurable – which we’ll examine in the next section.
Question 1.5
Why is the chance of winning the lottery uninsurable?
a. The underwriter cannot calculate the chance of it happening to quote a premium. □
b. You cannot insure risks where there is a chance of making a gain. □
c. It is against public policy. □
d. The National Lottery organisers have their own insurance. □
E Features of insurable risks
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As we have just seen, not every risk is insurable. In addition to being financial, pure and
(generally speaking) particular, the following features must also apply for a risk to be
insurable:
• a fortuitous event;
• insurable interest;
• the risk itself must not be against public policy; and
• the risk must generally not be a one-off.
E1 Fortuitous event
To be insurable, the happening of the event must be fortuitous. In other words, it must be
accidental or unexpected and not inevitable, for the insured.
It must certainly not be deliberate on the part of the insured. An example of a non-fortuitous
loss is an insured setting fire to their property. In contrast however, a theft may have required
careful planning by the thieves, but still be unexpected for the insured.
E2 Insurable interest
Insurable interest is the legally recognised financial relationship between the insured and the
object or liability that is being insured.
Other examples of insurable interest not necessarily based on ownership would be:
• Having responsibility for someone else’s goods because they are stored in your
warehouse.
• Having responsibility for maintaining the pavements, where you might have a legal
liability should anyone fall over and damage themselves.
Activity
Make a note of the various ways you might think insurable interest can arise; then refer to
your notes when you study chapter 2.
Chapter 1
E3 Public policy
It is commonly recognised in law that contracts must not be against public policy or go
against what society considers to be the right or moral thing to do. Insurers should not,
therefore, cover risks that are against public policy.
For example, it would be against public policy to insure the risk of incurring a fine for a
criminal offence. The risk may appear to have all the features of an insurable risk, as the
event may be considered fortuitous (accidental) and the insured has an insurable interest,
since they suffer financial loss as a result of the fine. However, it is clearly unacceptable to
be able to insure against paying a fine, because the purpose of the fine is to punish the
individual. Providing insurance for this type of risk may encourage people to break the law.
Insurance cover for fines

You may see coverage for fines in some insurance policies that you review. This will be for
administrative fines rather than criminal fines – an example of this might be a fine imposed
by the customs officials at a port if shipping paperwork is not completed properly.
Before we move on to consider the pooling of risks, let’s consider the importance of
homogeneous (similar risks) exposures to insurers, as contrasted with one-off risks.
E4 Homogeneous exposures
A sufficient number of exposures to similar risks, historical patterns and trends will enable an
insurer to forecast the expected extent of future losses. We could call such risks ‘objective
risks’.
In the absence of a large number of homogeneous exposures (i.e. similar risks) the task is
harder, as a pattern is more difficult to determine. In extreme cases where there is no
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historical data, the risk becomes a subjective one from an insurer’s point of view.
Whereas fortuitous loss, insurable interest and not being against public interest are absolute
requirements, the concept of homogeneous exposures is an ideal. There are occasions
when an insurer will need to use less than fully reliable historical data when fixing premiums,
such as:
• a completely new risk (such as new technology); and
• risks in parts of the world not previously open to that insurer.
For example, insurance is available for satellite launches, even though instances of such
launches are fairly infrequent and any failure generally catastrophic. However, wherever
possible, an insurer looks for homogeneous exposures in order to utilise as fully as possible
the law of large numbers. The greater the number of similar risks to insure, the closer the
actual outcome will be to what was expected in terms of losses.
Activity
Visit www.lloyds.com and find examples of the London Market insuring famous people’s
body parts. Consider how the insurers work out the risks and the premium to charge.
Question 1.6
What does the term 'homogeneous exposures' mean?
a. Underwriters have never seen anything similar before. □
b. Underwriters have some historic data to work from. □
c. The risks are similar to those seen before. □
d. The risks are all from the same geographic location. □
F Pooling of risk
The basic concept of insurance is that the losses of the few who suffer misfortune are met by
the contributions of the many, who are exposed to similar potential loss. An insurer gathers
together relatively small individual sums of money from people who want to be protected
financially from similar kinds of perils. The insurer sets itself up to operate a pool. In fact, as
we shall see, insurers operate a number of separate pools for each different class of
insurance they underwrite.
Contributions, in the form of premiums from many insureds, go into this pool. From the pool,
payments are made to compensate the losses of the few.
The premiums must be large enough, in total, to meet the losses in any one year. In addition,
they should cover the costs of operating the pool and provide an element of profit for the
insurer. The insurer endeavours to make sure that the premium paid by the insured is
proportionate to the risk which they introduce to the pool.
Balancing the books for an insurer

The basic business equation that the insurer has to balance is premium ≥ claims +
operating costs.
In words, the premium has to be greater than or equal to the total of claims and
operating costs.
F1 Law of large numbers

In operating the pool, insurers benefit from the law of large numbers. This states that where
there are a large number of similar situations, the actual number of events occurring tends
towards the expected number.
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In operating the pool, insurers benefit from the law of large numbers. This states that where
there are a large number of similar situations, the actual number of events occurring tends
towards the expected number.
The law of large numbers can be illustrated by considering the flip of a coin, which can result
in a head or a tail combination. On the simple mathematics of the situation, you would expect
to get the same number of heads and tails, because the chance of getting either is 50%.
However, flipping the coin just 20 times may not give us the 50/50 split we would expect.
Flipping the coin 10,000 times, we would almost certainly see a result of approximately 5,000
heads and 5,000 tails. The law of large numbers, therefore, operates to give a result which is
in keeping with the underlying probability (likelihood of something happening) of, in this
example, 50% heads and 50% tails.
Applying the principle of large numbers to insurance enables the insurer to predict fairly
confidently the final cost of claims in any one year. This is because insurers provide cover
against a large number of similar risks, and the final number of actual loss events tends to be
very close to the expected number – provided the conditions under which the original data
were gathered remain constant. This enables the insurer to calculate likely losses and so
confidently charge a fixed premium.
In addition to the law of large numbers, the insurer also uses historic data to predict the
pattern of claims payments and ultimate claims values. Obviously, this historic data is of
limited use when the insurer moves into new classes of business; in this case, the law of
large numbers becomes more of a key tool for calculating likely losses.
F2 Equitable premiums
To operate a pooling system successfully, a number of pools must be set up – one for each
main group of risks being underwritten. For example, an individual pool for, say, marine or
aviation hull insurance and another for property insurance must be set up.
Marine and aviation hull insurance

Marine or aviation hull insurance is insurance against physical damage to a ship or an
aircraft. For more about classes of business see chapter 3.
Chapter 1
Each insured wishing to join the pool must be prepared to make an equitable (fair)
contribution to that pool.
When deciding on an equitable contribution, insurers take into account the different elements
of risk brought into the pool by each of the insureds. These are often referred to as
discrimination factors. Arriving at a premium is a complex process and the correct
assessment of risk is extremely important. This will ensure that a fair premium is charged,
that also allows for cost-covering and profit-making. This is the task of an underwriter when
considering an individual risk.
Premium calculation is covered in more detail in study text LM2.
G Reasons for buying insurance

An individual (or a business) will decide whether or not to purchase insurance based on:
• their attitude to their potential risk;
• what price they are prepared to pay for the peace of mind which insurance gives; and
• the extent to which they feel they have a choice about insuring the risk.
Insurance has been meeting this need for a very long time. It has its origins in the different
kinds of situation where financial protection is required against the possibility of suffering
some misfortune or loss.
But how is peace of mind achieved? As we have seen, the primary function of insurance is to
act as a risk transfer mechanism between the insured and the insurer but of course the
transfer of risk does not prevent the bad things from happening, but it provides a form of
financial security and peace of mind for the insured.
For example, the large unknown financial risk that a company faces of their factory burning
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down is transferred to the insurer and replaced by the much smaller and certain cost of the
premium.
H Primary and secondary functions of

insurance
Insurance brings many benefits to policyholders and to society as a whole.
The primary Spreading the risk. By transferring the risk to insurers and by insurers then sharing the
functions of risk between themselves either as co-insurance or reinsurance the risk is spread far
insurance are: wider than it would be if it was retained by the insured.
Providing a degree of certainty. In exchange for the premium, and subject to any
limitations in the insurance itself, the insured swaps the uncertainty of loss for the
relative certainty provided by the insurance protection.
Transferring risk. Individuals and organisations should consider the risks that they are
exposed to and decide whether they can eliminate them altogether, whether they can be
mitigated to an acceptable level or whether they can be transferred. In exchange for a
modest premium, the insurers will accept the financial risk being transferred to them thus
providing the peace of mind for the insured, whether a large corporation or an individual.
The secondary Companies do not have to set aside large sums of money as ‘safety nets’ for dealing
functions of with losses. Without insurance, large sums would need to be built up and set aside to
insurance can be cater for unforeseen contingencies, such as fire, flood or liabilities.
described as:
Companies can be confident to look to expand their business. Without insurance, if
they are acting prudently, they should be putting funds aside for the ultimate ‘rainy day’.
With insurance, they are still vulnerable to loss but it is not their funds at risk and this
may encourage an entrepreneurial approach in, say, opening up a factory or launching a
new product. Insurance provides security from which to develop such innovations.
Jobs are protected. If there is a fire in a factory then there will be physical damage. But
often it does not stop there and there are other consequences. If the factory is the only
one that the insured owns, then their business may well grind to a halt until the factory
can be rebuilt, unless they can find alternative premises in a hurry.
Losses are reduced in size and number – this might sound odd when we have
previously said that insurance does not stop the bad things happening but insured risks
will generally have the benefit of risk management from the insurers (if not performed by
the insured themselves) as the larger risks will be surveyed. This can identify areas for
risk improvement and loss prevention.
Insurers are largely investors of funds – benefiting the economy. Firstly, there is a
time delay between the receipt of premiums and the occurrence of claims. This creates a
premium reserve. Once claims have occurred there is a further period (that can be very
extensive for third party claims involving personal injury or illness) before the claims are
actually paid. This element is a claims reserve.
‘Invisible’ exports – only about 25% of the business written in the London Market is
from UK-based insureds hence the insurance exported from London results in a flow of
money (premiums) into London thus assisting the financial position of UK PLC.
Invisible exports
Instead of exporting something physical (or visible) such as cars, or foodstuffs, invisible
exports are made when services are sold and exported. The service in this case is
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insurance. Most of the business of the London Market is insuring risks overseas, for
overseas clients, so the insurance is exported to those other countries.
Activity
Review the latest Lloyd's Annual Report which can be downloaded from www.lloyds.com/
lloyds/investor-relations and see what it says in the opening pages about the geographic
spread of business coming into the Lloyd's Market.
Compare it with the company market by looking at the International Underwriting
Association (IUA) latest statistics report which can be found here: bit.ly/2x17nR6.
Question 1.7
Which of these activities is a secondary function of insurance?
a. Risk transfer. □
b. Peace of mind. □
c. Ability to enhance the business. □
d. Job satisfaction □
I Compulsory insurance
In Risk management on page 1/4, we touched briefly on the insurance that has to be
purchased whether the insured wants to or not. The UK Government has legislated to make
certain forms of insurance compulsory and the same is true in many countries around the
world, although the categories that are compulsory differ from country to country.
In the UK, the Government acts as an insurer in its own right in providing certain benefits for
individuals. These are important and include welfare benefits, unemployment benefits and
retirement benefits. However, this will not be the case in every country. Many countries, for
Chapter 1
example, have a form of workers’ compensation cover (giving fixed benefits), which is
provided by the private sector rather than by the Government.
Internationally, there is considerable variation in the provision of health insurance by the
Government or the private sector and in how these two sources are balanced.
The UK Government has tended to make the insuring of certain risks – relating to legal
liability or negligence – compulsory through legislation. The aim is to make sure that funds
are available to compensate the innocent victims of many types of accident (though not all).
Those made compulsory by law can be summarised as follows:
• Private individuals. Motor insurance and public liability insurance in respect of the
ownership of dangerous wild animals and/or dangerous dogs are compulsory for private
individuals.
• Professions and businesses. Motor insurance and employers’ liability insurance are
both compulsory for every business which uses motor vehicles on a road and has
employees respectively.
Public liability insurance is also compulsory for specific trades and professions, including
riding establishments. Solicitors and other professionals, including insurance intermediaries,
must have professional indemnity insurance. Marine pollution liability insurance is
compulsory, as is liability insurance for operators of nuclear reactors.
The main reasons why certain forms of insurance are compulsory are:
• To provide funds for compensation. The main objective of compulsory insurance is to
provide means by which persons injured, or suffering loss, through the fault of others may
receive compensation. There would be little point in awarding damages to someone if
there were no funds to meet the award. Compulsory insurance ensures, as far as
possible, that funds are available when damages are awarded by a court, even though
the person who caused the injuries may lack the necessary financial resources.
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• In response to national concerns. Apart from riding establishments, the areas where
insurance has been made compulsory represent areas of greatest national concern.
• Reputation of the profession. Alongside the concept of national concern, compulsory
insurances which will provide compensation also serve partially to protect the reputation
of certain professions such as solicitors.
We will now look at the nature of and rules introduced by the insurances that are compulsory
within the UK.
I1 Employers’ liability insurance

The Employers’ Liability (Compulsory Insurance) Act 1969 made it compulsory for
employers in Great Britain to effect employers’ liability (EL) insurance. This insures
employers against their liability to pay compensation to employees who sustain bodily injury
or disease, arising out of and in the course of their employment.
There is a list of exemptions from this requirement, mainly relating to family members and
government agencies. However, in practical terms most employers have to insure this risk.
The minimum required limit of indemnity has been increased and now stands at £5m,
although the insurance market provides £10m as standard. There is also a requirement for
employers to display their EL certificates, provided by insurers, at each place of work.
The Employers’ Liability Tracing Office (ELTO) database contains all new and renewed
policies from 1 April 2011, together with any older policies that have had claims made on
them or had been traced through the voluntary code that had existed previously. Insurers
have to publish this information within three months (i.e. if a risk incepts on 1 January, the
information must be with ELTO by April the same year), including information relating to
subsidiary companies and all employee reference numbers (ERNs).
Set up to provide claimants and their representatives with quick and easy access to a
database of Employers’ Liability (EL) policies through an online enquiry facility, ELTO is
designed to help find the insurer of their former employer where the claimant is suffering
from a disease/injury caused at work. The use of unique reference numbers such as the
ERN also assists with tracing businesses that are no longer in existence by the time a claim
is actually made.
Although ELTO is a mechanism for tracing potential insurance cover, it is not itself a body
that compensates and finding something on its database is no guarantee that the insurance
will respond.
Activity
Find the EL certificate which should be prominently displayed in your office – check areas
such as the staff room, kitchen or notice boards. Is it up to date? If you cannot find it there
check your intranet as it can legally be stored electronically as well, as long as it is in a
central area. Search for www.elto.org.uk/ to find out more about the Employers Liability
Tracing Office.
I2 Motor insurance
The Road Traffic Act 1988 (as amended) stipulates that it is illegal to cause or permit the
use of a vehicle on a public road (extended now to include ‘any other public place’) unless an
insurance policy is in force, covering third party property damage and third party bodily injury
or death.
The EU has had a significant influence in the area of compulsory motor insurance.
This has been prompted by the nature of certain freedoms, relating to the movement of
goods and people, which are at the heart of the Treaty of Rome. Although compulsory third
party personal injury cover featured as part of UK law well before the First (EU) Motor
Insurance Directive in 1972, many subsequent changes to UK law have been prompted by
EU directives. Compulsory third party property damage cover and the requirement to be able
to trace the insurer of a vehicle from its registration plate are two examples. The EU
directives do not currently regulate comprehensive motor cover (i.e. cover for the insured car
or driver) or get involved in the compensation regimes in individual countries.
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I3 Public liability insurance: riding establishments
One of the provisions of the Riding Establishments Act 1970 is that all proprietors of riding
establishments must have public liability insurance.
The insurance must indemnify the insured against claims arising from the use of the
insured’s horses. This would include injuries sustained by both persons riding the horses and
members of the public. The insurance must also indemnify the horse riders themselves
against any liability they may incur for injury to members of the public, arising out of the hire
or use of the proprietors’ horses.
I4 Liability insurance: dangerous wild animals and/or

dangerous dogs
Apart from motor insurance, the other forms of liability insurance which are compulsory for
private individuals are in respect of the ownership of dangerous wild animals or
dangerous dogs.
The nature and scope of such insurance is not defined in the Dangerous Wild Animals
Act 1976 or the Dangerous Dogs Act 1991. However, the local authority, which issues the
appropriate licence, must be satisfied as to the adequacy of the insurance. In general,
insurers are not willing to issue a policy that would only cover the liability arising out of the
ownership of the dangerous wild animal or dangerous dog.
This is a very specific risk and given that the insurance would most likely only be purchased
by owners of dogs who were concerned about their dogs’ behaviour, the prospect of a claim
is higher than it might be if all dog owners bought the policy. Instead the insurer would
probably only be prepared to insure the risk as an extension to another insurance policy held
by the insured/owner. Such a policy could be the household policy, where it would be
covered within the public liability section.
I5 Professional indemnity insurance

Professional indemnity (PI) insurance is compulsory for certain professions. These include
solicitors and others such as accountants and insurance intermediaries who are authorised
by the FCA.
Chapter 1
I5A Solicitors
The Solicitors Act 1974, as well as the Solicitors Regulation Authority Indemnity Insurance
Rules, states that solicitors must hold professional indemnity insurance. This insurance must
indemnify the solicitor against claims for financial loss suffered by clients as a result of the
solicitor’s professional negligence.
Consider this…
If you are given bad advice by a solicitor you may not realise it for some time, maybe
years. You may want to make a claim against the solicitor at that point. They might be a
small high street firm that could try to argue they have no money to pay you, but they
should have PI insurance in place to deal with your claim.
I5B Insurance intermediaries

Insurance intermediaries authorised by the FCA must have PI insurance. Appointed
representatives and introducer appointed representatives are not required to have this form
of insurance, since everything they do is undertaken on behalf of a principal that is
responsible for their actions. FCA rules require insurance intermediaries to hold liability
insurance in respect of financial loss caused by their professional negligence up to
substantial limits both for individual losses and on an aggregated basis (approximately £1m
for a single claim, although FCA limits are actually expressed in euros).
Activity
If you work for an insurance intermediary, find out what your firm’s PI policy covers.
J The claims handling process
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We have already looked at the fact that most insurance is not compulsory and that insurance
is purchased to transfer the risk.
It is important to understand the role of insurance as a service industry. Customers, even
for compulsory insurance will remember the service provided by their insurer; they can and
will move their business depending on the experience that they have with the insurer.
The insurer ‘experience’ is generally centred on claims handling, as before a loss happens
most insureds pay little or no attention to their policy. The concept of the claims experience is
as important in commercial insurances as with personal lines insurance; although the buyer
of commercial insurances may be more sophisticated about the claims process and need
less ‘hand-holding’ they will have equally high expectations as to service – perhaps higher.
Positive customer outcomes
Central to the work done by an insurer is that their ethos and staff behaviours are ethical in
every way and that the business understands the importance of ethical behaviours in
delivering positive customer outcomes.
The principles set by the FCA reflect the professional and ethical standards that should
guide those who work in insurance as they go about their day-to-day activities. However, it's
vitally important for an industry that relies on trust for customers to have confidence that they
are dealing with people who are putting their interests first; not because they have to, but
because they believe it's the right thing to do.
Organisations with a record of great customer service, treating every customer fairly and with
respect, build themselves a good reputation; those who don't won't be recommended to
other people.
The CII Code of Ethics provides members of the insurance profession with a framework in
which to apply their role-specific technical knowledge in delivering positive consumer
outcomes. Under the fifth 'Core duty' within the Code, members are required to: 'treat people
fairly regardless of: age, disability, gender reassignment, marriage and civil partnership,
pregnancy and maternity, race, religion and belief, sex and sexual orientation'.
On the Web
CII Code of Ethics: bit.ly/2UnNlgn.
'Financially Inclusive Customer Outcomes: A companion to the Code of Ethics':
bit.ly/3OcCoVh.
FCA Consumer Duty

In 2021 the FCA launched a consultation on a new Consumer Duty which sets higher
expectations in the standards of care that firms provide specifically to consumers. The
proposal relates to products and services sold to 'retail client', which would broadly include
consumers and also SME businesses. We examine this in more detail in Consumer Duty
on page 6/9.
Claims handling is discussed in more detail in study text LM2; however, a brief overview is
provided here (covering the key aspects that an insurer should consider in relation to the
service that is being provided to customers, individual or commercial).
J1 Claims personnel
An efficient claims department, staffed by competent and professional claims personnel, is
vital to ensure the proper use of an insurance company's financial resources. The role of
claims personnel is to:
• deal efficiently and fairly with all claims presented;
• identify quickly those claims which are not valid and advise the insured and their
representatives quickly;
• assess and calculate the funds to be set aside to pay the claim for both indemnity and
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any attendant costs (e.g. for experts). These funds are known as reserves;
• instruct any necessary experts;
• settle claims cost-effectively; and
• liaise with colleagues in other areas of the insurer’s operation to provide them with data
relating to claims, both individual and in terms of trends and patterns.
Activity
Write some notes down about the things that might be important to you if you owned a
ship and it sank, leading you to make a claim on your insurance policy.
What are your expectations of your insurer in terms of their claims handling service?
More detail about the claims process itself can be found in chapters 5 and 8.
Chapter 1
Key points
The main ideas covered by this chapter can be summarised as follows:
Concept of risk and risk transfer
• There is no universally recognised definition for the term risk.

• The acceptance of an unknown future potential risk by an insurer for an agreed
premium is a way of defining insurance as a risk transfer mechanism.
Risk management
• Risk can be avoided, minimised, managed or transferred.

• Risk management is identification analysis and control of risk.
Components of risk
• These include uncertainty, level of risk, peril and hazard.

• Peril is the thing that is being insured against, for example, fire.
• Hazard is something about the risk that might make the operation of the peril worse, for
example, a thatched roof on a property, no sprinklers in a factory or a bad attitude to
safety on a ship.
• Hazard can be described as physical or moral and both will be considered by insurers.
Categories of risk
• Risks can be categorised as pure and speculative; fundamental or particular; and

financial or non-financial.
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• Some risks are insurable and some are not.
Features of insurable risks
• An insurable risk must be of a financial nature, pure rather than speculative and
particular rather than fundamental.
• The risk must be a fortuitous event and there must be insurable interest.
• The risk must not be against public policy.
• One-off risks are not generally insurable although Lloyd’s underwriters have a
reputation for considering one-off risks.
Pooling of risk
• All insureds contribute to the pool by paying in a fair premium for the risk that they
bring to the pool and they can make claims on the pool should they suffer losses.
• Insurers use the law of large numbers to assist them in working out the fair contribution
together with historic knowledge.
Reasons for buying insurance
• An individual (or a business) will decide whether or not to purchase insurance

based on:
– their attitude to their potential risk;
– what price they are prepared to pay for the peace of mind which insurance gives;
and
– the extent to which they feel they have a choice about insuring the risk.
Primary and secondary functions of insurance
• The primary functions of insurance are:

– spreading the risk;
– providing the insured with a degree of certainty; and
Key points
– transferring risk.
• Secondary functions of insurance include the following:
– Companies do not have to set aside large sums of money as 'safety nets' for
dealing with losses.
– It allows businesses to expand.
– Jobs are protected.
– Insurers have the opportunity to invest their funds, benefiting the economy.
Compulsory insurance
• Certain insurances are compulsory such as motor and employers’ liability.
Claims handling process
• Insurance is a service industry and customers will usually remember the claims
service.
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Chapter 1
Question answers
1.1 b. Risk-averse.
1.2 c. Risk control.
1.3 b. Low frequency and high severity.
1.4 a. Good moral hazard.
1.5 b. You cannot insure risks where there is a chance of making a gain.
1.6 c. The risks are similar to those seen before.
1.7 c. Ability to enhance the business.
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Self-test questions
1. What is the best definition of insurance being a risk transfer mechanism?
a. Moving your interest in an asset to insurers. □
b. Moving the actual risk of a loss to insurers. □
c. Moving the financial impact of a loss to insurers. □
d. Moving the cost of business to insurers, □
2. Which of the following is not a main purpose of risk management?
a. Identifying, analysing and controlling risk. □
b. Giving shareholders confidence that the business is being run properly. □
c. Providing a disciplined approach to the quantification of risk. □
d. Reducing the operating costs of a business. □
3. Which of these types of loss is an example of high frequency/low severity?
a. Low speed car crash. □
b. Ship colliding with a dock. □
□
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c. Damage to a wind turbine.
d. Two aircraft colliding at an airport. □

4. How would you best describe the sentimental value of a piece of jewellery?
a. A fundamental risk. □
b. A pure risk. □
c. A non-financial risk. □
d. A specialist risk. □
5. Which option best explains the difference between peril and hazard?
a. Peril causes the loss and the hazard can possibly make it worse. □
b. Hazard causes the loss and the peril can possibly make it worse. □
c. The underwriter calculates the premium based on hazard and does not consider □
peril.
d. The underwriter calculates the premium based on peril and does not consider □
hazard.
6. How does a speculative risk differ from a pure risk?

a. A speculative risk is one where there is no possibility of a positive outcome. □
b. A pure risk is one where there is no possibility of a positive outcome. □
c. A pure risk is uninsurable but a speculative one can be insured. □
d. There is no difference between them. □
Chapter 1
7. Which key insurance term is used to define something which is neither expected nor
intended?
a. Speculative risk. □
b. Fundamental risk. □
c. Certainty. □
d. Fortuitous event. □
8. For what main reason do insurers pool risks?
a. To increase their investment income. □
b. To reduce their operational costs. □
c. To enable them to charge each client a fair premium. □
d. To be able to buy cheaper reinsurance. □
9. Identify the option which is not a primary reason for purchasing insurance.
a. Peace of mind. □
b. Risk transfer. □
c. Spreading the risk. □
□
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d. Investment in the insurance industry.
10. Which insurance is compulsory for individuals in the UK?

a. Third party motor. □
b. Buildings. □
c. Household contents. □
d. Pet. □
You will find the answers at the back of the book
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2
Chapter 2
Basic insurance legal
principles and terminology
outcomes
Introduction
A Contract law 7.7
B Consideration 7.7
C Insurable interest 7.7
D Duties of disclosure during contract negotiation 1.1
E Cancellation of insurance contracts 7.7
F Proximate cause 1.2
G Indemnity 1.3
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H Contribution 1.4
I Subrogation 1.5
Key points
Question answers
Self-test questions
Learning objectives
• describe the essentials of a valid contract of insurance;
• explain the principle of good faith;
• define the meaning of and application of proximate cause;
• describe the principle of indemnity and how it is modified; and
• explain contribution and subrogation and how they are applied.
2/2 EP2/October 2022 London Market insurance essentials (EPA)
Introduction
In the previous chapter, we reviewed some fundamental principles of insurance such as risk.
Chapter 2
In this chapter, we are going to review the basics of the law that applies to insurance
contracts. It is important to understand that insurance contracts share many of the same
fundamental ingredients as any other type of contract but with a few added elements which
are specific to insurance.
Key terms
Consensus ad idem Consideration Contract law Deductible

Duty of fair Estoppel Excess Financial value
presentation
Franchise Fulfilment of a Good faith Inception
contract
Indemnity Insured perils Offer and Proximate cause
acceptance
Subject-matter of Subject-matter of the Sum insured Tort
insurance contract
Underinsurance Valid contract Voidable contracts
A Contract law
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The English law of contract is essentially a law of deals or agreements. It involves the
relationship between two parties, one of whom agrees to perform or do something if and
when the other party also performs or does something. A contract may be defined as ‘an
agreement, enforceable by law, between two or more persons to do, or abstain from doing,
some act or acts, their intention being to create legal relations and not merely to exchange
mutual promises.’ (English Law, Smith and Keenan)
Applying this definition to insurance, it may be said that an insurance contract is: an
agreement, enforceable by law, between an insured and an insurer.
The insured agrees to pay a premium to the insurer and abide by the terms and conditions of
the policy. In return, the insurer agrees to pay to the insured a sum of money or provide
something of monetary value, on the happening of a specified event, e.g. the submission of
a claim.
Main purpose of insurance

As we saw in chapter 1, the main purpose of an insurance contract is to pay claims to
policyholders should they suffer loss or damage covered by the terms of the insurance.
The idea effectively restores the insured to the position that they were in before the loss,
e.g. repair the building that has been damaged by fire to the state it was in before the fire
occurred.
This is called ‘indemnifying the insured’ and will be discussed further in Indemnity on page
2/21.
How do both parties enter into this legally binding agreement and what conditions must be
satisfied by both parties to ensure that the contract is a valid one? What will the results be if
the ingredients are not all there?
First, let us look at the essentials of a valid contract and then at the way in which an
insurance contract differs from other commercial contracts.
Chapter 2 Basic insurance legal principles and terminology 2/3
A1 Essentials of a valid contract

To ensure that a valid and enforceable contract is formed, an agreement must satisfy certain
criteria. Two of the most important are:
Chapter 2
• offer and acceptance; and
• consideration.
There are other important elements of a valid contract which are listed below.
Contract element Explanation
Intention to create a legal agreement The parties are acting deliberately.
Possibility of performance Can what is being agreed in the contract actually be done? A contract to
fly to the moon on a hang glider would be impossible to perform.
Capacity to enter into legal relations Capacity is a legal concept and deals with the legal ability to make
decisions. With one or two exceptions, young people under the age of
majority (18) are not deemed capable of entering into contracts, and nor
are those with diminished mental abilities.
Consensus ad idem (literally: meeting Do both parties believe they are agreeing to the same thing – see the
of minds) ‘Consider this’ box below.
Legality Is the contract legal? An example of an illegal contract would be one to

commit a criminal offence.
Certainty Are the terms of the contract clear and unambiguous and are all parties
entirely clear as to their obligations?
Consider this…
If you went to a railway station and asked for a ticket to Ashford, meaning Ashford in Kent,
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and the cashier sold you a ticket for Ashford, Middlesex, do you think there has been a
meeting of minds – literally did both parties think they were agreeing to the same thing?
Question 2.1
A property insurer looks at a request for insurance and sees that the risk location is
Newcastle. He does not ask any questions but believes that this is Newcastle upon
Tyne. The risk is in fact in Newcastle under Lyme. What key aspect of a contract is
missing in this example?
a. Offer. □
b. Acceptance. □
c. Meeting of minds. □
d. Consideration. □
A contract may be declared invalid or set aside if it is missing any of these essentials. It
cannot exist in law even though the parties involved may want it to. The legal term for this is
that it is void ab initio (from the beginning).
Reinforce
Think of a contract as a cake which has a specific recipe that must be followed. If you
miss out one of the ingredients, then however much you might want to make a cake, you
will have a soggy mess or a dry pile!
All parties to a contract must act in good faith which means that they must not mislead one
another. Note how this provision relates to both parties which means that both the insured
and the insurer have this obligation – we will come back to what this actually means later in
the chapter.
Only in certain circumstances is a document necessary and a simple contract does not need
to be evidenced in writing. Insurance policies are simple contracts. It follows that a policy
does not have to have been issued for cover to exist.
Chapter 2
Although a policy is not required, it is good practice for all parties to have some evidence of
the agreement. In the London Market this is embodied in the concept called Contract
Certainty which requires all parties involved in the contract to know exactly what the terms
are before inception and that some sort of evidence of the contract is issued to the insured a
short time after inception. Evidence might be a copy of the Market Reform Contract (MRC)
(also known as a slip) or a broker-created evidence of cover such as the Broker Insurance
Document.
The MRC will be discussed in more detail in Placing a risk on page 5/15 and in study
text LM2.
Simple contracts
The term ‘simple’ in relation to an insurance contract is a legal one and refers to the legal
status of the contract, not the ease of understanding the contents.
We will now discuss the basic legal principles of ‘offer and acceptance’ and ‘consideration’
as mentioned above.
A2 Offer and acceptance

A contract comes into existence when one party makes an offer which the other accepts
unconditionally.
This statement seems straightforward enough and the following sections show how offer and
acceptance work in practice.
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A2A Unconditional acceptance
It is easier to see how unconditional acceptance works by looking at an example.
Let us consider the following conversation which is based on personal lines insurance
where the use of proposal forms and direct contact (without a broker) is more usual.
Bill (from ABC Insurer): On the basis of your Proposal Form I can offer you cover,
subject to driving being restricted to the named persons you have listed, for £350.
Tom: I accept.
In this example, Tom’s acceptance does not alter any of the terms of Bill’s offer. He has not
tried to change any of the terms. The acceptance is said to be unconditional.
A contract is formed, subject to the other essential elements being present. To be effective,
acceptance must be the final and unqualified agreement to the offer.
A2B Conditional acceptance
If new terms are introduced, the so-called acceptance becomes a new offer (a counter-offer)
which is open to be accepted or rejected by the person who made the original offer.
Now consider an alternative response by Tom.

Bill (from ABC Insurer): On the basis of your Proposal Form I can offer you cover,
subject to driving being restricted to the named persons you have listed, for £350.
Tom: I accept, so long as I can have 'any driver' cover.
In this scenario, a contract has not been formed as Tom has not unconditionally accepted
the offer.
Not until Bill accepts Tom’s counter-offer, without further conditions, is a contract formed. A
counter-offer operates as a rejection of the original offer: Hyde v. Wrench (1840).
Reinforce
Think about a simple activity such as going shopping for some clothes. You want a certain
item and you ask the shop assistant for it, but the shop assistant suggests an alternative
Chapter 2
piece of clothing instead. This is like a game of table tennis with the offer and acceptance
being bounced between both parties.
A2C Postal acceptance

The general rule is that the contract is made when the acceptance is received by the offeror
(the person making the offer). However, where the parties have agreed to use the post as
the method of communication, acceptance is complete at the point when the letter of
acceptance is posted.
This rule applies even if the letter is delayed, or is lost or destroyed in the post and never
reaches the offeror: Household Fire Insurance Co. v. Grant (1879). In this case, Grant
applied for shares in the Household Fire Insurance Company. The insurance company
properly posted the letter accepting his offer, but it never arrived. The court decided that the
offer had been accepted when the acceptance was posted, so there was a valid contract.
With the development of electronic communication methods, the law has had to extend to
cover these situations; however, a further discussion of this area of the law is outside the
scope of this syllabus but will be covered in more detail if you study unit M05.
A2D Offer and acceptance in practice
Let us now bring together everything we have learnt so far about offer and acceptance and
see how it works in an insurance situation – see Example 2.1.
Example 2.1
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Kevin buys a new car and knows that he needs to have insurance in place before he can
pick up the car from the showroom. Kevin gives details of the risk to be insured to
Flashcar Insurance and it responds by quoting him a premium of £500 together with some
requirements such as having an alarm. This is an offer from the insurers to Kevin.
He accepts the premium and terms by notifying the insurer and the insurer is then ‘on risk’
(another use of the term ‘risk’, which in this context means that there is now a contract
with Kevin and any losses covered by the policy, which occur from that point onwards, will
be met).
B Consideration
We shall now consider the essential element of consideration, which is necessary to ensure
that a valid contract is formed.
Contracts must be supported by consideration to be valid. But what exactly is consideration?
It was legally defined in Currie v. Misa (1875) as ‘some right, interest, profit or benefit
accruing to one party, or some forbearance, detriment, loss or responsibility given, suffered
or undertaken by the other.’
Consideration may be described, simply, as each person’s side of the bargain which
supports the contract. The consideration from the insured is generally the payment of the
premium and the consideration from the insurers is the promise to pay valid claims.
Consideration does not have to be in money form and often commercial contracts are made
on the basis of a consideration that may be expressed in shares, or even a truly nominal
amount of money such as 1p.
Reinforce
Remember that the main reason for buying insurance is the insurers’ promise to pay
valid claims.
C Insurable interest
Insurable interest is not one of the ingredients of a basic contract but is one of the elements
necessary to create a valid insurance contract. It may be simply defined as 'the legal right to
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insure arising out of a financial relationship recognised at law, between the insured and the
subject-matter of insurance.'
C1 Features of insurable interest

The following features of insurable interest • subject-matter
may help to clarify the definition:
• need for a legal relationship, but not necessarily
ownership
• financial value
It is important to consider some related terms • insurer’s own insurable interest

to clarify other aspects of insurable interest:
• timing of the insurable interest (particularly anticipated
insurable interest)
We’ll now examine each of these features and terms in turn.

C1A Subject-matter
Within the concept of subject-matter, it is important to look at both subject-matter of
insurance and the subject-matter of the contract.
Subject-matter of This is what is actually being insured, be it a physical thing such as a building, a car, a ship
insurance or some livestock, or the potential to be held legally liable for loss or damage to someone
else or their property.
Subject-matter This is the relationship that the insured has with the subject-matter of insurance. It might be
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of the contract ownership of property, responsibility for the safe-keeping of goods stored in a warehouse,
or liability as the owner of a restaurant if the customers contract food poisoning.
C1B Legal relationship

The relationship of the insured with the subject-matter must be recognised in law for
insurable interest to exist. Merely feeling responsible for something is not adequate;
however, it is important for insurers handling international business to appreciate that the
legal position differs from country to country and what is recognised under English law may
not be under another country’s law, and vice versa.
C1C Financial value
The idea here is that should something bad happen then the insured may have a financial
downside, either because something has been damaged or destroyed, or because they have
incurred a legal liability which may result in an award of damages against them.
Activity
Think about yourself or a member of your family and note down here what insurable
interests they might have through owning or being responsible for something.
Then think about the company you work for – use common sense at this point and think
about the things they own or are responsible for – note down your answers and then go
and speak to a senior colleague and see what they think.
Question 2.2
Maria runs a warehouse where she accepts customers' goods for storage. Her
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contract with the customers makes clear that she is responsible for keeping them
safe whilst in her care. Which insurance principle allows her to buy insurance against
her liabilities?
a. Offer. □
b. Acceptance. □
c. Consideration. □
d. Insurable interest. □
C1D Insurer’s own insurable interest
Insurers have an insurable interest allowing them to purchase reinsurance to protect them
from the risks they have written. Reinsurance is considered further in chapter 3.
C1E Timing of insurable interest
Timing of insurable interest: a summary

Life insurance contracts. Insurable interest must exist at inception but need not exist at
the time of a loss.
Marine insurance contracts. Insurable interest must exist at the time of a loss but need
not exist at inception although a reasonable expectation of acquiring one is required.
General insurance contracts. A general rule that insurable interest must exist both at
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inception and at loss; however, an anticipated interest may be sufficient at inception.
C2 Creation of insurable interest

In this section, we will briefly review the different ways in which insurable interest can arise
or be created.
Common law
We all owe duties to each other and have certain rights under common law. These give rise
to insurable interests. The most obvious examples of this are ownership or exposure to
liabilities to others under the law of negligence.
For example, a local council is responsible for ensuring that pavements are well-maintained.
This responsibility is often called having a duty of care. If they breach that duty of care, or in
other words fail to keep the pavements safe, someone might fall and hurt themselves. The
council runs the risk of being found to be negligent by not looking after the pavement
properly and will have to pay the injured person damages for the injuries. Liability insurance
covers those damages if the insured is found to be negligent in law (not if they just feel a bit
guilty!).
Contract
There are situations (when we enter into a contract) in which we accept greater
responsibilities and therefore liabilities than those imposed by common law. For example, a
landlord is liable under contract to their tenant to maintain the property; however, they can
enforce responsibilities onto the tenant under the same contract.
Statute
There are some statutes which impose a positive duty, thus creating an insurable interest.
Examples of these statutes imposing duties are:
• Settled Land Act 1925; and
• Repair of Benefice Buildings Measure Act 1972.
These statutes make the tenants responsible for the upkeep of the buildings they occupy.
This gives the tenants an insurable interest in the building.
Statutes modifying insurable interest

There are also statutes which restrict liability and, therefore, restrict the financial value
element of insurable interest. For example:
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• The Carriage of Goods by Sea Act 1971 limits the liability of a carrier to a specific
amount.
• Hotel Proprietors’ Act 1956 – liability only exists if a room has been booked and
damage occurred during the time the guest was entitled to use the accommodation.
• Carriers’ Act 1830 – no liability for goods such as gold, silver, watches, clocks, jewellery,
china, pictures worth more than £10 unless value declared when goods put into the care
of the carrier.
Activity
Consider the following scenario and list all the different parties that might have an
insurable interest, with reasons why.
A shopping mall is owned by a property development company and has 30 different
shopping outlets and a small cinema. The shopping outlets are rented to a number of
different companies but the owners run the cinema themselves.
There is a food court within the complex, together with a supermarket, pharmacist and a
dry cleaner.
Cleaning is done by an independent company which is responsible for washing floors,
cleaning toilets and ensuring that litter is collected.
D Duties of disclosure during contract

negotiation
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D1 Good faith
When talking about contracts in general terms earlier in this chapter we looked at the nature
of all contracts. All parties to a contract must act with good faith and this is also true with
insurance contracts.
Many contracts involve the purchase of a tangible product such as a piece of furniture or a
car. A purchaser can inspect a tangible item at the time they buy to check that it is of good
value. Provided that the seller does not mislead them (for example, by showing a sample
that is unrepresentative of the actual product), the law expects buyers to satisfy themselves
about the obvious properties of the product they are buying.
There are some obvious difficulties when trying to apply this principle to insurance contracts.
Consider this…
Although the potential customer can inspect a specimen wording for a policy before
proceeding with the purchase, this is clearly not the same as being able to inspect a table
before buying it and in reality will rarely happen.
A policy is only really ‘tested’ in terms of adequacy and quality when a claim is made – and
neither the insured nor the insurer wants this to happen. Thus, from the point of view of the
proposer the insurance product is intangible – it is a promise as yet untested.
If we look at insurance from the insurer’s viewpoint, we can also see that the insurer is reliant
upon a proposer for most of the important details about the risk that is being offered. At the
start of their relationship, the insurer knows nothing about the prospective insured and the
risk being presented for consideration.
D1A Principle of good faith in pre-contract negotiations
The principle applies equally to both the proposer and the insurer throughout the contract
negotiations and essentially means that both parties should be open and transparent with
each other in the sharing of key information relating to the risk.
However, it applies rather differently to each party. It is the proposer who has the duty to
disclose all material facts about the risk to the insurer. The nature of the subject-matter of the
insurance contract and the circumstances surrounding it are facts known mainly by the
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insured.
The insurer, on the other hand, must be entirely open with the proposer in other ways, for
example, they cannot:
• introduce new non-standard terms into the contract that were not discussed during
negotiations; or
• withhold the fact that discounts are available for certain measures that improve a risk.
Consider this…
An example of a measure that would improve the risk is the fitting of a sprinkler system for
a fire policy on a commercial building.
On the face of it, the duty is a difficult one for the insured in particular to bear as, whether or
not they are asked, they have to:
• disclose all material information; and
• know what is material.
Two key concepts that will be discussed in this section are disclosures/non-disclosures –
when something is said, or not, and representations/misrepresentations – when something is
said but it is not always accurate/true.
D1B Legal position if the insured is a consumer
A consumer is defined as someone who is buying insurance wholly or mainly for purposes
unrelated to their business, trade or profession.
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The consumer, under the Consumer Insurance (Disclosure and Representations) Act
2012, has a duty to take reasonable care not to make a misrepresentation to their insurers,
and whether they have exercised reasonable care will be considered in light of all the
relevant circumstances.
There are two types of misrepresentations under this Act which are:
• careless;
• deliberate or reckless.
The insurer will have to show that without the representation they would not have entered
into the contract or would have done so on different terms. Additionally, the burden is on the
insurer to argue that a representation was not just careless, it was deliberate or reckless.
A misrepresentation is deliberate or reckless if the consumer:
• knew that it was untrue or misleading, or did not care whether or not it was untrue or
misleading; and
• knew that the matter to which the representation related was relevant to the insurer, or
did not care whether or not it was relevant to the insurer.
If the insurer can prove deliberate or reckless, their remedies are avoidance of the contract
and refusing all claims, and in addition, need not return any premium unless it would be
unfair to the consumer to retain them.
If the representation is merely careless, then the insurer’s remedies depend on what they
would have done without the representation.
If there are claims involved:
• If they would not have entered into the contract on any terms, then they may avoid the
contract and return the premium.
• If they would have entered the contract but on different terms (not including those relating
to premium), then the contract is to be treated as if it had been entered into on those
terms if the insurer so requires.
• If the insurer would have entered into the contract but would have charged a higher
premium, then the insurer may reduce proportionately any amounts to be paid on a claim.
If there are no claims involved:

• The first two bullets above apply as before.
• An insurer can give notice to the consumer either of the termination of the contract or the
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variation of the contractual terms.

• Insured can also give notice to terminate.
• Premiums must be repaid for the balance of the contractual term.
• Any claims arising during a notice period before termination will have to be considered in
the usual way.
Innocent misrepresentation does not give the insurer the right to decline a claim payment for
personal insurances.
The Claims Handling section of the Insurance: Conduct of Business Requirements (ICOBS)
contains the main rules and guidance. The over-arching requirement is that insurers must
not unreasonably reject a claim. ICOBS currently includes a definition of what would be
considered ‘unreasonable’ grounds for rejecting a claim (unless there is evidence of fraud)
from ‘consumers’, as follows:
• non-disclosure of a fact material to the risk which the policyholder could not reasonably
be expected to have disclosed; and
• non-negligent misrepresentation of a fact material to the risk.
D1C Legal position if the insured is not a consumer
The Insurance Act 2015 contains the law on disclosure and representations for non-
consumer insureds.
Under section 3 of the Insurance Act, the insured must make a fair presentation of the risk to
the insurer. Fair presentation is defined as:
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‘one which makes disclosure of every material circumstance which the insured
knows or ought to know, or disclosure which gives insurers sufficient information to
put a prudent insurer on notice that it needs to make further enquiries.’
The definition goes on to say that the disclosure should be on matters which are reasonably
clear and accessible to a prudent insurer and that material representations as to fact should
be substantially correct, while those relating to a matter of expectation or belief should be
made in good faith.
Case study
The leading case that explained the duty of disclosure in insurance contracts was Carter
v. Boehm (1766).
In this case, Mr Carter had taken out an insurance policy against the fort he was governor
of (in Sumatra) being taken by a foreign enemy whilst being aware that the fort was not
built to withstand attacks from European powers. When it was taken Mr Boehm refused to
pay out on the insurance.
In this case, Lord Mansfield said:
'Insurance is a contract upon speculation. The special facts, upon which the contingent
chance is to be computed, lie most commonly in the knowledge of the insured only: the
underwriter trusts to his representation, and proceeds upon the confidence that he does
not keep back any circumstance in his knowledge, to mislead the underwriter into a belief
that the circumstance does not exist, and to induce him to estimate the risk as it did not
exist.'
D2 Materiality
The concept of materiality is one which is not new and exists in the pre-existing law on
disclosure and representations, which is contained in the Marine Insurance Act 1906 and
states that ‘Every circumstance is material which would influence the judgment of a prudent
insurer in fixing the premium or determining whether he will take the risk’.
Prudent insurer
This definition says a ‘prudent insurer’, not the actual insurer – this is a very important
point in relation to the legal tests for materiality of any particular piece of information.
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What is material information?
Examples of the types of information that insurers consider to be material include:
• Physical hazard. For example, information about the construction of a building and the
type of heating system installed.
• Moral hazard. For example, whether the proposer has any criminal convictions, any
insurance declined previously or any fraudulent claims discovered.
However, the key changes within the Insurance Act are:
• the insured cannot data dump on the insurer – the presentation must be reasonably clear
and accessible; and
• the insurer has to consider whether the presentation invites further questions to be asked;
the burden to ensure these questions are asked, if needed, is on the insurer – this
complies with the insured’s duty to place a prudent insurer on notice that they need to
make further enquiries. This is very important as, although the responsibility is equally
balanced between the insured and the insurers, the latter have a responsibility to review
and ask questions as they will have no redress if this is left until a later date.
The Act sets out the scope of the insured’s actual or imputed knowledge – this includes in an
organisation, matters known by senior management and those responsible for the
organisation’s insurances. This includes the brokers, although it does not include any
confidential information which might be held by the broker, for example, which the broker did
not obtain from their client.
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The Act also discusses in section 4 what the insured ‘ought to know’ and the definition of this
relates to the conduct of a ‘reasonable search of information available to the insured’. The
key here is that the larger the organisation, the more widespread the internal request for
information will have to be. The word ‘reasonable’ is very subjective, so this element is likely
to be a topic of litigation at some point in the future!
The final point to note about assumed knowledge on the part of the insured is contained in
section 6; here, it says that information the insured suspects but deliberately refrains from
confirming will be included as what the insured ‘knows’. As a result, no opportunity remains
to turn a blind eye to matters.
There are a number of matters that do not have to be disclosed to insurers. Section 3 of the
Act states that in the absence of enquiry, the insured does not need to disclose information:
• that lessens the risk;
• that the insurer knows;
• that the insurer ought to know;
• that the insurer is presumed to know; or
• waived by insurers.
Examples of information that does not need to be disclosed
This is either because the insurer ought to know them or could find them out.
Matters of law Everyone is deemed to know the law. It follows that those actions that the proposer
needs to take in order to comply with the law do not need to be declared specifically,
even if material.
Public knowledge Examples:

• A state of war exists.
• A particular area or country is subject to natural catastrophes, subsidence,
hurricane or flood.
• Industrial processes that are standard for the trade.
Factors that lessen It would be unusual not to advise the insurer of factors that lessen the risk. This is
the risk because they are matters that usually have the effect of producing a lower premium or
better cover. Nevertheless, there is no requirement to disclose them. The fitting of an
intruder alarm is an example of an improvement to a theft risk that the insured/
proposer is not bound to disclose.
Information waived by Such facts would include those where the proposer has not answered a question on a
the insurers proposal form, or has just inserted a dash. If the insurer does not follow this up, it is
considered to have waived its right to that information. The insurer cannot claim non-
disclosure in the future.
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The only exception might be where the non-answering of any question could be
construed as answering the question in the negative. Each question on a proposal
form should be present for a reason, in that it relates to information in which the
insurer is interested. It is therefore important that insurers check carefully at an early
stage whether any further information is required to enable them to make their
decision.
Information that a This only applies in circumstances where an insurer has actually carried out a survey.
survey should have Provided that the proposer has not concealed anything from the surveyor, if the
revealed surveyor misses something of importance that is material information, the insurer
cannot subsequently claim non-disclosure by the insured. This is because the insured
has no way of knowing what the surveyor may or may not have noted during a survey.
Information that the This category needs an explanation because different rules apply to people acting in
insured does not know their private capacity as compared with commercial insurances. Broadly speaking the
tests are:
• whether the requirement for disclosure was reasonable; and/or
• whether the fact was material.
Specific examples include:
• Information covered by policy terms. The insured is not required to declare
those things that are specifically dealt with by policy terms. For example, the fact a
person enjoys underwater pastimes is not relevant when applying for a personal
accident insurance, if the policy excludes such activities. Obviously, if the policy
does cover underwater activities, then the matter becomes material.
• Spent convictions. Under the terms of the Rehabilitation of Offenders Act
1974 (as amended by the Legal Aid, Sentencing and Punishment of Offenders
Act 2012 (LASPO))*, certain offences are treated as if they had never been
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committed after differing periods of time. The timing varies according to the
severity of the sentence imposed.
– In England and Wales the rehabilitation period for a fine is one year.
– A custodial sentence of four years or more is never 'spent'.
– For offenders under 18 years of age, the rehabilitation periods are halved.
A custodial sentence of four years or more is never ‘spent’. For offenders under 18
years of age, the rehabilitation periods are halved.
* Although there are some exceptions, the practical effect for insurers is that it is perfectly in order for a proposer
to state that they have had no convictions provided that they are 'spent' under the terms of the legislation. It
follows that insurers that have imposed restrictive policy terms under a motor policy solely because a driver has
been convicted of a motoring offence, must remove those restrictive policy terms once the conviction becomes
'spent'.
Activity
Review Annex A of the ABI’s Insurers’ Approach to People with Convictions and
Related Offences: An ABI Good Practice Guide (2019) for the full list of rehabilitation
periods now applicable in England and Wales. Available at: https://bit.ly/3zf21Pk.
Section 5 of the Insurance Act specifically deals with the knowledge of the insurer and
defines that the insurer knows something if it is known by one or more of the individuals who
participate on behalf of the insurer in the decision to take the risk (i.e. usually the
underwriters). However, the Act specifically also includes those who might accept the risk
outside the insurer’s organisation such as someone acting under a delegated underwriting
agreement.
When it comes to the ‘ought to know’ or ‘presumed to know’ categories, the Act also
defines these concepts:
• The insurer ought to know something if it is known by an employee or agent of the
insurer and the information ought reasonably to have been passed on to the person
making the decision to accept the risk, or if the information is held somewhere within the
organisation and is readily available to the person making the decision.
• The insurer is presumed to know things which are common knowledge and things which
an insurer operating in this class of business would reasonably be expected to know.
Just as we saw with the insured, the insurer cannot turn a blind eye to information that they
suspect but choose not to follow up on.
Chapter 2
Activity
Think about which other areas of the insurer’s organisation might know relevant
information which should be shared with the underwriters, do you think the claims team is
an obvious area?
How best do you think information should be shared within the business?
D3 Role of the broker

The insured’s knowledge includes the knowledge held by one or more of the individuals
responsible for the insured’s insurance which can, therefore, include brokers, but there is no
longer a separate expressed duty of disclosure on the part of the broker as there was
previously.
D4 Remedies
Under the Insurance Act, there are a number of remedies for breach of the duty of fair
presentation. The first decision to be made is whether the breach was deliberate or
reckless, or neither deliberate nor reckless. The second decision is whether the breach took
place as part of the original risk placement or in relation to any variation of the contract.
Original placement
If the breach was deliberate or reckless – which is defined as the insured knew that they
were in breach and did not care – the insurer can avoid the policy from the start (ab initio)
and they can retain the premium. The insurer has the burden to prove that the breach was
deliberate or reckless.
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However, if the breach was neither deliberate nor reckless, the insurer’s remedy depends on
what their response would have been to the correct information, had it been presented:
• If the insurer would not have entered into the contract at all if the correct information had
been presented, then the insurer can avoid the contract but they must return the
premium.
• If the insurer would have entered into the contract on different terms (not including the
premium) then the contract will be treated as if those terms were included.
• If the insurer would have charged a higher premium, then the remedy is not that an
additional premium can be charged, but that any claim will be reduced on a proportionate
basis. Therefore, if the insurer feels that they have in fact only received 80% of the
premium they were expecting, only 80% of the value of any otherwise valid claim will
be paid.
Variation
A variation or change to an insurance contract can occur at any point after the original
placement is concluded. A variation can be anything from a simple change, such as the
correction of a spelling mistake, or something more substantial, such as adding a new asset
to an insurance policy. Whatever the nature of the change the new law applies specific
remedies depending on the nature of any breach of the duty of fair presentation:
• If the breach is deliberate or reckless, insurers can terminate the contract from the time of
the breach and do not have to return the premium.
• If the breach is neither deliberate nor reckless and the premium stayed the same or
increased due to the variation, and
– if the insurer would not have agreed to the change they can treat the contract as if the
change never took place, but they have to return any additional premium charged; or
– if the insurer would have agreed to the variation but on different terms (including
premium) the contract will be treated as if the changes have taken place and if more
premium should have been charged the claims will be impacted as explained
previously.
• If the breach is neither deliberate nor reckless but the premium was reduced because of
the change, and
– if the insurer would not have agreed to the change, then they can treat the contract as
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if the change had never happened, but any claims will be penalised as the insurer has
now received less premium than they originally wanted; or
– if the insurer would have agreed to the change but on different terms these different
terms will be applied.
D5 Contracting out
It is possible for the parties to the insurance contract to agree that the provisions of the
Insurance Act 2015 will not apply and, therefore, that the previous law on disclosures will
apply. However, the Insurance Act places a burden on the insurer to be very transparent in
their explanation to the insured of the impact of doing this. If the insurer does not do this, any
apparent contracting out within the documentation may have no legal effect. The Act
anticipates different requirements based on the relative customer sophistication and also
recognises that if a broker is involved the broker also has a duty to their client to alert them
to the potential disadvantages of this choice.
D6 Compulsory insurances
There are certain insurances which are required by statute – a fact which impacts on an
insurer’s rights following a breach of the duty of disclosure. The most common example is
motor insurance (third party personal injury and third party property damage). The Road
Traffic Act 1988 prohibits the insurer from avoiding liability on the grounds of certain
breaches of good faith.
Exactly the same rules of disclosure apply to motor insurance contracts as to other non-life
classes of insurance. However, the law is primarily concerned that the innocent victims of
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road accidents should be adequately compensated, and this aim would be defeated if an
insurer could avoid paying claims on the grounds of non-disclosure by the insured.
Insurers must, therefore, meet all claims for personal injury and property damage made
compulsory under the legislation. Once they have done so, they then have a right of
recovery against the insured. They will usually seek to recover what they can in such
circumstances.
D7 Insurer’s duty of disclosure

The insurer also has a duty of disclosure to the insured. In order to fulfil this duty, the insurer
must also behave with good faith; for example, by explaining clearly the various products
available and the options available to the insured and an insurer's ability to reduce premium
if an insured fits sprinklers or superior locks to property.
Activity
If you, or someone you know has car, house or contents insurance, have a look for the
Key Facts document; the tool used by insurers to try to set out the details of the cover in
clear terms to ensure that they remain compliant.
D8 Modification by policy wordings

For many types of insurance, instead of a duty of disclosure that only lasts until the risk is
actually placed, the insurer requires a continuing duty to disclose material information. In
such cases, there must be a specific policy condition that makes this clear.
At inception
Under common law, the duty of disclosure starts when negotiations begin and ends when the
contract is formed (at inception). From that point until renewal negotiations take place, there
is no requirement for the insured to declare material information unless it affects the policy
cover. For example, if the value of property increases or a car is sold and another purchased
it is clear that the insurer must be advised because the policy requires a specific
endorsement to accommodate the change in risk. However, a policyholder does not need to
disclose a conviction for fraud (which would be a material fact for all general insurance
policies) until the following renewal.
The exception would be if there was a specific policy condition which extended the duty of
disclosure so that it became a continuing one.
On renewal
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On the renewal of a policy, the insured’s duty of disclosure is revived for general insurance
(non-life) policies.
All general (i.e. non-life) insurance policies (such as fire, theft, liability and certain marine and
aviation policies) are contracts that are renewable, usually after twelve months. When the
contract ends it is customary to offer renewal terms. If accepted, a new contract is formed.
The duty of disclosure is revived during the period of negotiation and applies as for new
contracts.
It is important that you distinguish between the requirements for short-term policies and
those for long-term policies (such as life and pensions policies).
Question 2.3
Why do insurers on long-term policies only require disclosure at the time of the
original inception, whereas short-term policies require it at every renewal?
a. Nothing is expected to change in a long-term policy. □
b. Each renewal is the creation of a new policy of insurance. □
c. Long-term insurers trust their clients more. □
d. General insurers do not trust their clients. □
Once the requirements for disclosure have been met in the negotiations leading up to the
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inception of a long-term contract, the duty of disclosure ceases. Once the policy is in force,
even if a material fact – such as the life insured’s health – changes, it does not need to be
declared. The only requirement for the policy to continue is that the insured pays the
premiums when they fall due.
Continuing requirement
Insurers are often concerned that their rights at common law are limited because they do not
need to be advised of certain material mid-term changes to a risk that they insure. They deal
with this situation in different ways for different classes of insurance. Not all insurers adopt
the same approach but the following table illustrates some of the issues.
Commercial property insurance A policy condition requires continuing disclosure of removal of property to
another location, or circumstances that increase the risk of damage to
property.
Motor insurances There is usually an onerous policy condition that requires continuing
disclosure of all material changes by the insured, during the currency of
the policy.
Public liability insurance The continuing requirement for disclosure for this class of business arises
from the fact that insurers tightly define ‘the business’ of the insured in
the policy. This means that the insured must notify any extension of their
activities for cover to apply. A condition requiring ongoing disclosure of
material information may be coupled with this.
Consider this…
Why might a public liability insurer want to know that a bowling alley that is being insured
is now going to open a café serving meals to the customers? What sort of information will
they want to know?
On alteration
During the term of a general (non-life) policy, it may be necessary to change the terms of the
policy. The insured may wish to increase the sum insured, change the description of the
property or add another driver to a motor policy. Where a change results in the need for an
endorsement to the policy, the duty of disclosure is revived in relation to that change.
D9 Limitation of an insurer’s right to information

In many cases it is the completion of a proposal form by the proposer that brings about
insurance. The insurer constructs the proposal form with the intention that it will draw out all
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the relevant information relating to the risk. However, even if a specific question is not asked,
the duty of disclosure means that the proposer must still disclose any information that is
material.
If a question is asked, but the proposer only provides partial information in response and the
insurer does not seek further details, then the insurer is deemed to have waived its rights
regarding this information. The proposer is not considered to have failed to disclose a
material fact in these circumstances. This applies to answers left blank on proposal forms or
where a proposer has given a vague description of a business.
If an insurer clarifies what it means by a ‘material fact’ by defining exactly what is required in
answer to a question on a proposal form, it is unable to claim at a later date that it required
wider or further disclosure. In effect, it cannot claim that there has been a failure to disclose
something material. This is the case in any situation where the insurer has requested what
they regard as relevant information relating to a defined period.
Use of slips in the London Market
The London Market is slightly different in that most risks are not placed using a proposal
form, but using a Market Reform Contract (still colloquially known as a ‘slip’) on which the
risk details are summarised for the insurers’ consideration. This document is drawn up by the
insurance broker and does not include any questions from the insurers. This does not mean
that the insurers cannot and should not ask any questions, just that they will do so following
the presentation of the risk by the insurance broker and not through a pre-set list of
questions which the proposer answers at the time of the first presentation of the risk.
When there has been a breach of the duty of good faith/duty of fair presentation by the
insured in relation to a non-consumer contract (subject to the exceptions noted above), the
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insurer will generally have the right to invoke one of the remedies in the Insurance Act which
include avoidance, revision of the terms and so on. Timing will vary depending upon the
circumstances. If an insurer chooses not to invoke their right to avoid the policy, it may
simply waive its right and treat the policy as remaining in force.
However, insurers must exercise care because their conduct may prevent them from
claiming that a breach of the duty of good faith/duty of fair presentation has occurred. For
example, if an insurer knows that the insured deliberately failed to disclose a material fact in
discussions leading up to inception of the policy, the insurer has the option to avoid the
contract ab initio. However, the insurer must not act in a way that suggests that they have
waived their right to avoid the contract. Such an action could be writing to the insured
invoking a seven-day cancellation clause. It is clear that in doing this the insurer accepts that
the policy is in force up to the date of cancellation.
The insurer has thus waived its rights and is estopped from avoiding the policy on grounds
of non-disclosure at a later date. Consequently, should a claim occur between inception and
the cancellation date, the insurer could not avoid payment of the claim on the grounds of
non-disclosure.
Estoppel
Estoppel is the legal term used for a bar or impediment that precludes a person from
asserting a fact or a right. It usually arises where one party’s conduct has been relied
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upon by the other.
• This is a complex area but the practical application is as follows: insurer has to be very
careful not to lead insured into a false sense of security concerning the policy validity.
• For example, insurers will want to carefully investigate an alleged non-disclosure or
misrepresentation as it is a serious allegation to make against the insured. If they do
not say anything about their concerns to either the broker or the insured then the
insured will potentially be under the impression that everything is fine and then will get
a nasty surprise when the insurers try and cancel the policy.
• At this point, the insured could claim estoppel – saying that they had relied on the
silence from the insurers as evidence of everything being satisfactory and it was unfair
to now cancel the policy.
• There is a chance that a court might agree with them, depending on the actual facts of
the case, and insurers would end up not being able to cancel the policy.
The key is the insurer cannot unnecessarily delay any decision it makes to avoid or cancel
the policy, as fundamentally that would be unfair to the insured.
E Cancellation of insurance contracts

Once an insurance contract has been concluded, it is expected to continue until the agreed
expiry or renewal date. Some insurances are designed for short periods – for example, travel
insurance. Others such as motor, fire or home insurance are renewable contracts that will
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continue, typically, for one year whereby the insurer usually offers terms for renewal at the
end of that period. There is no obligation upon the insurer to offer renewal terms.
However, the FCA principle of fair treatment of customers, coupled with the requirement to
provide customers with information so that they can make an informed decision regarding
their insurance arrangements, implies that the insurer must alert the customer to the fact that
cover will expire and that renewal is not being offered ‘in good time’, which is determined by
the point in the renewal process at which the information may be most useful.
Put even more simply, if an insurer is planning not to renew a client’s policy, it must warn the
client in enough time for the client to make other arrangements.
There are some situations in which either the insurer or the insured may wish to cancel cover
during the currency of the policy. This is governed by the written terms and conditions in the
policy.
E1 Insurer’s rights
Most general insurance policies have a cancellation condition. This allows the insurer to
cancel, provided that a letter is sent to the insured’s last known address (usually by recorded
delivery or registered post) giving 14 days’ notice of cancellation. The period of notice is not
standard, some insurers state 10 days’, others 30 days’. If the insurer invokes this
cancellation condition a pro rata return premium is sent to the insured, representing the
unexpired portion of the risk.
This is not common practice at all, but it could happen. Examples would be if there has been
difficulty with a claims settlement and the insurer feels that the insured has acted
unreasonably and certainly if the insured has been guilty of fraud in connection with a claim.
Some policies that provide war coverage (particularly in the marine market) have
cancellation provisions which operate in two ways:
• To allow cancellation on short notice but with immediate re-activation allowing the
insurers to increase the premiums if the subject-matter insured is likely to enter high risk
areas, such as the waters off Somalia.
• To allow immediate cancellation of the policy if war breaks out between any two of five
named countries.
E2 Policyholder’s rights
It is less common for the insured to have cancellation rights. Some insurers permit this in
their wordings, even allowing a proportionate return of premium. However, it is much more
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common for the policyholder to have a right to cancel, but for the insurer to be entitled to
charge for the cover already provided at their short-period rates. These rates represent a
significant increase on the pro rata premium to reflect the fact that the insurer has spent
sometimes significant amounts of money setting up a new policy. (Insurers must take care
that these rates do not appear to be ‘unfair’.)
E3 Other means of terminating insurance contracts

As with any other contracts, termination may be as a result of the fulfilment of the contract or
as a result of some problem in relation to the contract.
E3A Fulfilment
This means that the contract has been fully performed – it has done its job in other words. In
an insurance sense, this will depend on matters such as the extent of financial coverage
available under the policy. If the policy will pay out a maximum of US$50m any one policy
year (irrespective of the number of individual claims) and has paid out that amount in the first
six months of the policy period, then the contract has been fulfilled. In reality the policy will
remain in force, but it will not be able to respond to any more claims.
E3B Voidable contracts

There are circumstances in which one party to a contract may set it aside. It is said to be
voidable at their option. This may arise under insurance policies where the insured is in
breach of a policy condition that places a continuing requirement upon them.
An example of this would be the deliberate failure to disclose material information – which
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gives the insurer the right to avoid the policy. It is a choice it must make, not an automatic
cancellation.
However, you must distinguish this type of situation from one in which the insured fails to
fulfil a condition relating to a claim. In this case, the insurer may have the right to avoid
paying the particular claim, but the policy will remain in force.
Example 2.2
Some policies have provisions whereby the insured must advise the insurers of an
incident that might give rise to a claim within a set period of time. Failure of an insured to
comply with such provision could prejudice their ability to have their claim paid by an
insurer, although the policy itself will still remain in force.
There may also be situations where the policy has never been in force. This would arise
where there was no recognised insurable interest at the outset. In such cases, the policy is
automatically void. This does not really amount to a termination since the contract has never
been in force.
F Proximate cause
In this section, we shall look at the causes of loss and how these relate to the cover provided
under a policy. We will then go on to apply the principles to straightforward claims situations.
When a loss occurs and the insured makes a claim for loss or damage, the insurer decides
whether to meet the claim by asking the following questions:
• Is a valid policy in force?
• Is the cause of the loss covered under the policy?
Answers to both these questions can usually be found by checking the policy terms and
conditions and the claims information. Sometimes, however, it is not clear what actually
caused the loss or it might take some time to unravel the story.
In these circumstances insurers look at the loss, all the possible causes and the relationship
between them, before deciding whether the claim is valid and then settling the claim.
F1 Meaning of proximate cause

Often the cause of a loss is straightforward and there is no need for a long investigation. A
fire caused by an electrical fault is easy to establish. If a policy covers the peril of ‘fire’ the
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claim will be payable.
If two vessels are in a collision at sea, their respective policies will respond, to the extent that
blame is apportioned according to the various policy wordings. There may need to be a lot of
discussion about the apportioning of blame, but there is no doubt that the policies will
respond because the cause is covered.
However, there are occasions when the cause of the loss is not so easily defined, either
because there is a chain of events or there is more than a single cause. In such cases, we
need rules to guide the way in which insurers should deal with such losses.
This is when insurers apply the doctrine of proximate cause.
Case study
An insurance policy covers a particular loss caused by an insured peril. Insurers look first
at the relationship between the peril and the loss to establish the proximate cause of the
loss. They must then decide whether or not the cause (peril) is insured, before paying the
claim. Proximate cause was defined in the case of Pawsey v. Scottish Union and
National (1907).
In this case which arose out of an earthquake in Jamaica, Mr Pawsey suffered fire
damage to his premises and made a claim on his policy. His policy, however, excluded
earthquakes and the court supported the insurers position and found that the earthquake
was the proximate cause of the loss as without the earthquake there would have been
no fire.
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Proximate cause means the active, efficient cause that sets in motion a train of events
which brings about a result, without the intervention of any force started and working
actively from a new and independent source.
The proximate cause of an occurrence is always the dominant cause and there is a direct
link between it and the resulting loss. A single event is not always the direct cause of a loss:
a loss sometimes occurs following a train of events.
A good way to picture the relationship between cause and effect is to imagine a row of
dominoes, all standing. Imagine the first domino is pushed over, knocking the second which
in turn knocks over the third and so on until they have all fallen down. The push of the first
domino sets in motion the chain of events which brings about the fall of the last domino. If we
take the fall of this last domino to represent a loss, then the push of the first domino is,
therefore, the proximate cause of the loss.
Imagine, however, that one of the dominoes does not fall as a result of the first domino
falling. Instead. it is pushed by an onlooker. In this case, the train of events stops and the
intervention of a new force, independent from the original train of events, becomes the cause
of the last domino falling. It is, therefore, the new proximate cause of the loss.
Example 2.3
A vessel suffers torpedo damage and limps into a safe harbour. A storm is developing and
the harbour master wants her out of the harbour so she is forced to leave. She sinks in
the storm.
In this case, the proximate cause of her loss is the damage caused by the torpedo as
without a large hole in her hull, she would have survived the storm.
In this practical example the proximate cause was important as storm damage was
insured; however, torpedo damage was not.
Consider this…
A factory building is struck by lightning during a storm and a fire starts which causes
significant damage. The factory insurance policy covers storms but not fire damage. What
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was the proximate cause, the lightning strike or the fire? Is it possible that the lightning
strike might not have caused a fire? Was the fire inevitable?
Consider this…
Some goods in a warehouse are damaged by water when the sprinklers are triggered.
The reason for the sprinklers being triggered was a fire in another part of the warehouse,
nowhere near where the goods were located. The goods are covered for fire damage but
not for water damage. What was the proximate cause of the loss? Was the only reason
the sprinklers were triggered the fire, or might it happen for other reasons?
Many situations involve, to a greater or lesser extent, several causes. In the case of Leyland
Shipping v. Norwich Union Fire Insurance Society (1918), Lord Shaw stated that
‘Causation is not a chain but a net’ going on to describe the proximate cause as ‘proximate
in efficiency’. This is particularly important as we consider more complex claims where there
may be more than one contributing cause, and the causes may be insured, uninsured or
excepted perils. These claims are beyond the scope of this course.
Question 2.4
While Michael was out riding his horse, he fell off. He was badly injured and was on
the ground for some time before he was rescued. During his convalescence, he
contracted pneumonia from being on the ground for such a long time and eventually
died.
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What was the proximate cause of his death?
a. Pneumonia. □
b. The fall from the horse. □
c. His medical treatment. □
d. None of the above. □
Question 2.5
A painting was in storage at an art gallery. The owner of the gallery was not aware
that the ventilation in the storeroom was not working properly and the painting's
wooden frame warped and cracked. One of the gallery employees went to collect the
piece, not realising it was already damaged and when he picked it up, the frame
collapsed and seriously damaged the painting. The artwork was insured for physical
damage but there was an exclusion for losses due to temperature/humidity changes.
What was the proximate cause of the damage?
a. The employee picking it up. □
b. The painting's own internal weakness. □
c. The climate related changes. □
d. None of the above. □
Which option did you go for with these questions? In the first example, if the person had not
fallen from the horse, would they have become ill? Probably not, so the chain in causation
leads from the fall.
With the painting, if it had not been affected by the ventilation failures would it have broken
when it was picked up? Probably not, so the chain leads back to the moisture damage.
F2 Nature of perils
Once the insurer has established the proximate cause of the loss, it must check whether the
peril is covered by the policy. Perils can be classified as follows:
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• Insured perils: those named in the policy as covered.
• Excepted or excluded perils: those named in the policy as specifically not covered.
• Uninsured or unnamed perils: those perils not mentioned at all in the policy.
Insurers decide whether or not a straightforward claim is valid by establishing into which of
the above categories the peril that was the proximate cause of the loss, falls. It is only
necessary to find the proximate cause of a loss where the events before the loss are not all
insured perils.
If they are all insured, the loss is covered. However, it may be necessary to determine which
peril caused a loss if different policy terms apply to different perils in the chain. If there were
a number of perils that caused the damage and it is impossible to allocate the damage to
different perils then the following rules apply:
• If one of the perils is excluded then nothing will be paid at all.
• If one of the perils is not mentioned at all (neither specifically covered nor excluded) then
the whole claim will be paid.
G Indemnity
The whole point of insurance is to ensure that when the bad things happen, someone other
than you pays for it.
When an insured peril causes a loss, the insured submits a claim to their insurer for the loss.
The insurer checks the validity of the claim and then, if valid, accepts it, agreeing to meet its
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obligation under the terms of the insurance contract. The actual settlement or the amount
payable by the insurer depends on a number of factors, including:
• the nature of the cover;
• the extent of the cover; and
• any conditions limiting the amount payable.
Most short-term (non-life insurance) contracts are contracts to indemnify the insured in the
event of a loss.
G1 Definition of indemnity
Indemnity can be defined as ‘financial compensation sufficient to place the insured in the
same financial position after a loss as they enjoyed immediately before the loss occurred.’
Reinforce
If your building is damaged by fire, insurance will pay for repairs that return it to the
condition it was in before the fire.
The key here is that the principle of indemnity does not anticipate the insured making a profit
from their loss but as we will see, not all insurances are contracts of indemnity.
Example 2.4
The importance of the principle of indemnity was emphasised by Brett, LJ, in the case of
Castellain v. Preston (1883):
Chapter 2
In this case, a house was being sold and during the sale process it was damaged by fire.
Insurers paid out to the sellers who were neither prepared to pay the insurance proceeds
to the buyers or to reduce the contractual sale price.
The key aspect of this case was to put in place the concept that the insured cannot profit
from his loss – he cannot receive more than he lost. Having received the full purchase
price from the buyers, the insurers were entitled to their funds back as the insured was in
no worse position than he had been before the fire occurred.
The very foundation, in my opinion, of every rule which has been applied to insurance law
is this, namely that the contract of insurance contained in a marine or fire policy is a
contract of indemnity and of indemnity only…and if ever a proposition is brought forward
which is at variance with it, that is to say, which either will prevent the assured from
obtaining a full indemnity, or which gives the assured more than full indemnity, that
proposition must certainly be wrong.
Question 2.6
The concept of putting the insured in the position they were in before the loss can be
expressed as:
a. Meeting of minds. □
b. Consideration. □
□
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c. Indemnity.
d. Subrogation. □
G2 Benefit policies
We can see straight away that some short-term policies are not policies of indemnity. The
policies in question are those that provide fixed benefits, mainly for accident and sickness.
These are short-term policies because the insurer has the option of inviting renewal at the
end of each period of insurance. However, there is no way that a price can be placed on the
loss of a limb or of sight, so the principle of indemnity cannot apply.
Insurers do try to take account of an individual’s circumstances and earnings when agreeing
to insure weekly benefits for temporary disablement. They do so because they do not wish
the policy benefits to act as an incentive for the insured to remain off work longer than
necessary.
Apart from life, pensions, annuity and investment contracts, policies that fall into the category
of benefit policies include:
• personal accident; and
• loss of licence for air crew.
Refer to
Aviation loss of licence insurance is covered in Benefit policies on page 2/36
G3 Options available to insurers

Now we have established that not all contracts of insurance are policies of indemnity, we will
consider the vast majority that do seek to provide exact financial compensation. For any type
of property insurance (and this would include the ‘own damage’ section of motor policies),
although the insured is entitled to receive indemnity (within the limits of the sum insured as
stated in the policy), there are different ways of providing indemnity. We shall examine these
in more detail.
There are a number of settlement options open to an insurer which will provide the insured
with the necessary indemnity, which are:
• cash;
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• repair;
• reinstatement; and
• replacement.
The options available apply only if they are stated in the policy. If they are not, the insured
has a legal right to financial compensation. These options have their origins in insurers
wanting to find the most economical way of providing indemnity. For example, in the past,
though not so much nowadays, insurers would have arrangements with some major
jewellers. Insurers would then be able to replace very expensive jewellery at a discount.
They would often do this rather than pay out the ‘insurance valuation’ price – which they may
have considered an inflated figure provided by a valuer.
Historically too, insurers would sometimes arrange for the repair of carpets that were
damaged. With the advent of ‘new for old’ type covers this practice has diminished.
Although these options have, therefore, historical significance, there are some helpful
aspects to them which mean that insurers have found it useful to retain these options.
Indeed some applications are even on the increase. Effectively, the options have remained
the same, but the practical applications have changed.
G3A Cash payment
For many years, most insurance claims have been settled by the payment of money by the
insurer directly to the insured. This is still the case, particularly with commercial insurances.
However, for personal insurances (in particular, home insurance) there has been, since the
1990s, a growing trend for insurers to use the replacement option through nominated retail
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chain stores. This will be looked at in more detail in Replacement on page 2/24 but it is
worth noting here what happens if the item offered by the insurer is not wanted by the
insured.
Many insurance companies now have close relationships with retailers, and the insurer’s
bulk-buying power often means they can get quite large discounts (often as much as 20%)
when purchasing goods.
However, the Financial Ombudsman Service (FOS) has indicated that where policyholders
do wish to have a replacement they should be allowed to choose where they purchase this
and they are entitled to a cash settlement if they cannot find an acceptable alternative. In
these circumstances, the insurer would not be entitled to reduce the cash settlement to take
account of the discount it would have received if the policyholder had bought the
replacement from one of the insurer’s nominated suppliers.
The settlement of claims for certain types of insurance always involves the payment of
money. These types include money insurance, fidelity guarantee, business interruption and
liability policies.
Who receives the money?

In the case of liability insurance, payment is made to the injured party, not to the insured.
G3B Repair
Where it is possible, insurers may opt to repair any damage to an insured item. In this way,
they can provide indemnity, perhaps at a lower cost than the insured might achieve, because
of the negotiating power of a large organisation.
The most common example is in motor insurance claims, so let’s look at an example to see
how this works in practice.
Example 2.5
Gary’s car is involved in a collision. He notifies his insurer which arranges for the damage
to be repaired at a garage approved by the insurer. The insurer pays the garage directly,
rather than paying money to Gary.
In this scenario, the ‘approved’ or ‘recommended’ repairer will provide the insurer with
guarantees in relation to workmanship and hourly rates, as well as the provision of courtesy
cars, in return for a flow of business from the insurer.
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It is important to remember that in many commercial policies of insurance, the item is

repaired. However, it is usual for the insured to pay the repair costs up front and get
indemnified by their insurer rather than (as often happens in motor insurance) the insurer
taking control of the repair through its own contacts.
G3C Replacement
The most common example of replacement as a means of providing indemnity is glass
insurance. Speedy replacement means further losses are minimised, such as when shop
front windows are smashed.
The most common example of replacement as a means of providing indemnity is glass
insurance. Speedy replacement means further losses are minimised, such as when shop
front windows are smashed.
As we have seen, replacement is also often used as a means of settling household property
losses. On these occasions, the policyholder simply orders a replacement item from one of
the household name retail stores and the item is paid for by the insurer.
Reinforce
The main benefit to insurers in offering replacement is that it can deter those who might
make false claims – thereby defrauding insurers. For example, if a fraudulent claim is
made for a damaged DVD player, the insured will hope to receive a cash settlement. If
however, the insurer exercises a right to replace, then the fraudulent claimant has two
DVD players and not the expected cash.
With the rise of internet auction sites (and therefore the ease with which goods can be
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sold for cash), the use of replacements may not necessarily deter a fraudulent insured
today but it can still act as a partial assistance to insurers.
G3D Reinstatement
Reinstatement is the fourth way that an insurer can provide indemnity. Reinstatement means
that the insurer agrees to restore a building (or piece of machinery) that has been damaged
by an insured peril.
However, this is not a popular option with insurers. The reason for this is that, unless the
policy specifies otherwise, they are bound to reinstate the property so that it is largely in the
same condition it was before the loss. In any event, they are their own insurers of the risk
during the period of reinstatement. Also, once they choose to reinstate, they lose the
certainty that the sum insured will be the maximum they have to pay out. This is reasonable,
since the insurer can hardly insist on reinstatement and then, once the sum insured is
exhausted, stop work regardless of whether or not the building is completely restored by
that point.
Difference between reinstatement and repair

The distinction between repair and reinstatement may not be immediately obvious.
Reinstatement would apply only to buildings (and occasionally machinery) and is
concerned with bringing the property back to its pre-loss condition. To achieve this
purpose the insurer effectively takes occupation of the premises (or what is left of them) to
reinstate. The option to repair does not carry with it the ‘occupation’ aspect.
G4 Application of indemnity
Property and liability policies are contracts of indemnity because a value can be placed on
the subject-matter insured. This principle also applies to pecuniary insurances, such as
business interruption. Remember from earlier in this section that life and personal accident
policies are not contracts of indemnity as the insured cannot be restored to the same
financial position after a loss.
G4A Property insurance

As a practical example of indemnity cover in respect of property insurance, imagine a fire
which destroys part of a school. Calculating the value of the loss may be a problem since the
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equipment is completely destroyed. The measure of indemnity is the replacement cost less
an amount for wear and tear. In the case of partial damage, indemnity is the repair cost less
an allowance for wear and tear. This is very much a theoretical starting point. Most property
policies incorporate some form of 'new for old' cover.
G4B Liability insurance

A liability policy provides indemnity to the insured in respect of their legal liability to pay
damages and legal costs (both for the insured and potentially the claimant’s costs/lawyers'
fees). The policy does not define the financial value of the indemnity, as this is often left to
the courts to decide. However, it does lay down the elements (such as the payment of
defence costs) to be included in an indemnity settlement. There will always be a limit to how
much the policy will pay in the event of a claim, and this will be stated in the policy. The client
and the insurers have to be clear about whether the insured’s defence costs are included
within the stated policy limit or will be paid in addition.
G5 Measuring indemnity
In this section, we will see how insurers measure indemnity for different classes of
insurance.
Our starting point must be the financial value of the subject-matter of the insurance, but how
is this financial value calculated? In the absence of policy conditions modifying the position,
in property insurance, the value of the subject-matter of the insurance is its value at the time
and place of loss. However, as we shall see, it is usual for policy conditions to apply which
alter this position. We start by looking at different categories and types of insurance and
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considering the standard cover provided by them, before examining possible extensions.
G5A Marine insurance
In a valued policy (which is the same as an agreed value policy), the insurable value is
agreed between the insured and the insurer. The insurable value of an unvalued policy must
be calculated using the formula in the Marine Insurance Act 1906. Thus, in both kinds of
policy, there is an identifiable insurable value, effective from the start of the period of
insurance (policy inception), and which is unaffected by subsequent market price variation. It
usually corresponds to the sum insured. See Agreed value policies on page 2/27 for more
information on valued/agreed value policies.
G5B Property insurance

The measure of indemnity for property is its value at the date and place of loss. This is a
very broad guideline and we must look at the different types of property insurance in order to
understand how the principle operates in specific cases.
Buildings: basic cover
This basic cover is referred to in the market as an ‘indemnity’ settlement, to distinguish it
from reinstatement (see below). Insurers calculate the indemnity for loss of, or damage to,
buildings as the cost of repair or reconstruction at the time of loss. They make allowances for
anything that cannot be exactly repaired as it was before the loss and where the
replacement has had to be new. This is termed betterment. It is very unusual for buildings to
be insured on this basis. What is much more common is insurance on reinstatement
conditions.
Reinstatement conditions
This is an extension of the principle of indemnity. Cover applies on the basis, not of a
discounted sum reflecting wear and tear, but the full reinstatement value at the time of
reinstatement.
Under property insurance policies, there are several different types of insuring clause, the
most common of which are the reinstatement memorandum and Day One reinstatement.
Reinstatement memorandum
The most important aspect of insurances subject to the reinstatement memorandum is that
the sum insured must represent the full value at the time of reinstatement. This means that
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the insured pays a premium based on the higher amount.

This particular clause allows a margin for error in estimating the sum insured. It states that
the insured value must be at least 85% of the actual value otherwise claims payment will be
reduced. This still leaves the insured with a problem if the claim amount exceeds the 85%
figure, since insurers will not pay more than the sum insured in the event of a loss – as this
effectively is underinsurance.
Reinstatement must be carried out without delay, though the insured is given flexibility about
where and how reinstatement takes place.
Day One reinstatement
This requires the insured to state the reinstatement amount on the first day of the cover.
Insurers provide an automatic uplift to allow for inflation (usually an extra 50% of the
'declared value') but only charge a modest increase for this inflation element (15% of the
premium).
The advantage of this system is that the reinstatement figure at day one is a relatively easy
figure to establish. Because of this, the day one value must be accurate. There is no 15%
margin for error as there would be with a reinstatement memorandum.
Consider this…
The reinstatement memorandum takes into account that a building might take two years to
rebuild and the costs might increase significantly during that time. The Day One
reinstatement relies on the reinstatement amount being accurate at the inception of the
policy and runs the risk of the costs escalating more than 50% of that figure during the
rebuild.
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G5C Machinery and contents
Basic cover
The starting point for the measurement of indemnity depends on whether there is a ready
second-hand market for the item.
• If there is a second-hand market then it is the second-hand price plus costs of
transportation and installation that would be payable.
• Where there is not a second-hand market, it is the cost of repair or replacement less an
allowance for wear and tear, if applicable.
Again it is important to emphasise that this is the starting point for considering property
insurance. In practice this very limited form of cover is rare.
Reinstatement conditions
Like buildings insurances, covers for machinery and contents (other than stock) also tend to
be on a reinstatement basis. This modifies the principle of indemnity. The reinstatement
memorandum is a common method of insuring such items and Day One reinstatement is
also possible in respect of machinery and contents. Again, it is important for you to note that
the sum insured must be calculated on the same basis as the proposed settlement formula.
Cash settlements under reinstatement conditions
One of the key elements of reinstatement conditions is the fact that in order to benefit from
the cover the insured must actually reinstate. If no reinstatement takes place, the insured is
entitled only to a settlement based upon strict indemnity. This means that wear and tear and
depreciation will be taken into account and a substantially lower amount may be paid.
G5D Stock
This may be considered under two headings:
• manufacturers’ stock in trade; and
• retailers’ and wholesalers’ stock in trade.
In both cases, the insured is not entitled to payment in respect of any potential profit element
on the sale of stock. This is one of the aspects that is catered for by a business interruption
(BI) policy. For more about BI policies, see chapter 3.
Chapter 2
Manufacturers' stock in trade This stock generally consists of raw materials, work in progress and
finished stock. Indemnity value is the cost of raw materials, at the time
and place of loss, plus labour and other costs incurred in respect of work
in progress and finished stock.
Wholesalers' and retailers' stock in Indemnity here is the cost of replacing the stock, at the time of the loss,
trade including the costs of transport to the insured's premises and handling
costs. It is not possible to insure stock on any kind of reinstatement basis.
G5E Household goods
Basic cover In general, indemnity is based on the cost of replacing the items at the
time of loss, subject to a deduction for wear and tear. However, a more
popular form of cover is available and almost universally used within the
UK – 'new for old' cover.
New for old cover This modifies the principle of indemnity by making no allowance for wear
and tear. Most insurers retain the deduction for wear and tear for items of
household linen and clothing, but apply cover for all other items on a 'new
for old' basis.
This is justified by setting the sum insured to represent the full
replacement cost of the household goods and the premium paid reflects
this. However, it does extend the principle of indemnity, but is far better
for the insured. For example, if their carpet is damaged then they receive
the cost of a new one, rather than having to obtain a new one and then
finding that insurers will only pay part of the cost.
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G5F Farming stock
In the case of livestock and produce, the local market price is the basis of indemnity.
Farming stock is different from other types of stock, as the insured is entitled to receive any
potential profit on sale. This is because the market price is both the buying price and selling
price at any time and there is no way of separating out the profit element.
G5G Liability insurance
In liability insurance, indemnity is measured as the amount of any court award (or more
commonly, negotiated ‘out of court’ settlement) plus the costs and expenses arising in
connection with the claim.
Where the insurer agrees that other expenses can be incurred these are included in the
amount payable. An example of such additional expenses would be the payment for
specialist medical treatment following an injury.
Activity
Review a household contents policy if you can get access to one, and then speak to as
many colleagues as you can who handle different types of insurance – to see what their
policies say about indemnity.
G6 Modifying indemnity
We have already seen some ways in which the principle of indemnity can be modified by
agreement between the parties. There are others that allow the insured to get either more or
less than a strict indemnity settlement.
G6A Agreed value policies
In agreed value policies the value of the subject-matter of the insurance is agreed at the start
of the contract and the sum insured is fixed accordingly. This value will be reviewed at each
renewal.
In the event of a claim, the value need not be proved at the time of the loss.
Agreed value, or ‘valued’ policies, are common in marine insurance. They may at times also
be used when insuring works of art and other objects, such as vintage motor cars, whose
true value may become a matter of dispute at the time of a claim. It is common to confine the
agreed valuation to total losses and to provide that partial losses are settled as if the policy
was unvalued, i.e. indemnifying the cost of repairs of a ship.
Chapter 2
If, therefore, a ship is agreed to be a total loss the insurers will pay out the agreed value,
even if that might be in fact in excess of the current market value of the ship, or alternatively
even if the current market value is in fact far higher.
In the first example, the insured will be able to purchase a replacement vessel and have
money left over, whilst in the second example, they will not have been fully indemnified as
they will potentially not have enough funds from insurers to replace the ship that has
been lost.
G6B First loss policies
There are occasions when the insured believes that the full value of the insured property is
not really at risk, in other words, a total loss or even a very substantial loss is unlikely at least
in relation to some perils that are being insured against. In this case, the insured may
request that their policy has a sum insured for some perils or even all of them that is less
than the full value.
Where insurers agree to this it is known as a ‘first loss’ policy. However, the insurer’s view of
the maximum amount realistically at risk is often similar to the insured’s estimate.
Consequently, the insurer will have calculated the premium for the full value taking these
factors into account. It follows, therefore, that insurers generally only give very modest
discounts on the ‘full value’ premium for risks insured on this basis. The reason for this is
that there may only be a slight reduction in their maximum exposure and they must still pay
all individual claims up to the first loss figure.
An example of this would be a factory which is spread over a large area of land. The
chances of a large scale theft of raw materials would be very rare given the scale of
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equipment needed to actually perform the theft; however, the chance of a fire covering the
whole site is more likely. In this case, the insured could obtain insurance for the full insured
value for fire risks, but take a lower first loss limit on theft related risks.
It is important to understand that the insured will receive a full indemnity for the total sum
insured for the perils concerned, however, the sum insured may be considerably less than
the full value of the overall risk. The insured takes a risk that any loss might, in fact, be
considerably larger than anticipated (for example a significant theft of raw materials) for
which they might not receive enough from their insurers to replace the materials stolen.
G6C New for old cover
Activity
Review some wordings relating to classes of business that your organisation might be
involved with and see if they are providing cover on a new for old basis. Consider what
benefit new for old cover offers not only to the clients but to the claims personnel in
working out the correct level of indemnity.
As we saw earlier, this type of cover usually applies to household contents policies. We
could also place commercial property risks that are insured on a reinstatement basis in the
same category. Each represents an attempt to replace at current costs.
G7 Limiting factors
There are a number of situations in which insurers may provide less than a full indemnity.
This may be either because of the insured’s choice of policy cover (as in the case of a first
loss policy), because of poor insurance arrangements or because full cover was not
requested. Policy terms may also restrict the insured’s entitlement to a full indemnity.
G7A Sum insured
The maximum amount that can be recovered under a property insurance policy is limited to
the sum insured. In liability policies, the maximum amount that can be recovered is the
indemnity limit plus agreed costs if paid in addition. If, following a loss, the amount needed to
provide indemnity is greater than the sum insured, the insured’s recovery is limited to the
sum insured.
Some policies have no limit stated. For example, there is no limit for third party personal
injury cover in a motor policy. In such cases indemnity is restricted only by the amount of the
court award (or the amount agreed in an out of court settlement), plus any other costs
Chapter 2
specifically covered by the policy.
G7B Inner limits or item limits
There are many policies that contain limits within the overall sum insured. The most common
of these is a household contents policy.
There is usually a single item limit (for gold, silver or similar items) of 5% of the sum insured
together with an overall sub-limit for all items falling into this category.
Many commercial policies will have sub-limits, perhaps for one particular location or peril
being insured against such as windstorm.
G7C Average
We have said that in property insurance, the amount payable by an insurer is limited to the
sum insured under the policy. This sum insured is the total value declared by the insured. It
is this figure that is used to determine the premium. We have already seen that equitable
premiums are central to the concept of pooling risks.
If the insured understates the value of subject-matter of the insurance when taking out their
policy, there is said to be underinsurance. The intention is that everyone who contributes to
the pool pays a premium that is based on the full value of the subject-matter of the
insurance.
It would not be equitable to accept a risk into the pool that is based on less than the full
value, as the premium charged would be too low. However, insurers cannot check that the
sum insured is adequate every time they take on a new risk. Instead, they limit their liability
by applying a policy term known as the average condition. In effect, this term means that the
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insured is considered to be their own insurer for the amount they have chosen not to insure if
there is underinsurance at the time of any loss. It means that even partial losses will be
shared between the insurer and the insured in proportion to the amount of underinsurance.
The formula used to calculate a claim payment, subject to the pro rata condition of average,
uses the sum insured, the value at risk and the loss, as follows:
sum insured
× loss
value of all goods at risk
The average condition is usual in commercial fire and theft policies and in virtually all
household policies. It cannot apply to liability insurances.
Variations in conditions of average
The principle that losses will be paid in proportion to what the insured has decided to set as
a sum insured, applies to most property insurance policies. However, insurers vary their
approach in different circumstances.
Special condition of average
You will recall that the basis of indemnity for farming stock is its market value, despite the
fact that this includes the insured’s profit margin. Insurers also take a more flexible view of
the application of average for farmers and apply the special condition of average to
agricultural produce and livestock. This is because the value of both may fluctuate
significantly. In the case of agricultural produce, this is particularly the case around harvest
time. The effect of the clause is to state that if the value at the time of loss represents at least
75% of the actual value, average will not be applied. The condition does not apply to items
that relate solely to growing crops, fences, gates and boundary walls, household goods or
overhead cables or poles and the standard ‘average’ condition would apply to such items.
(There may also be an option for the insured to insure for the ‘forward price’ of produce. In
this case, in the event of loss or damage, the value could not be ascertained until the forward
date chosen has been reached.)
Two conditions of average
These conditions are designed to apply to contents or stock, the insurance of which is
arranged on a floating basis (in more than one location), where specific insurance also
applies. The effect of the wording of these conditions is first of all to state that ‘average’
applies. However, it goes on to state that if there is a more specific insurance for the items
insured at any of the locations, only the excess value will be used to check whether average
applies.
Chapter 2
Question 2.7
A fire is suffered in a factory and the surveyor appointed by the insurer reports that
the factory was worth £1,000,000 before the loss. The policy says that the factory
has been insured for a value of £800,000.
If the claim is otherwise valid and presented for £500,000, how much will the insurer
deduct for average or underinsurance?
a. £300,000. □
b. £100,000. □
c. £50,000. □
d. Nothing. □
Be aware
In non-marine insurance, 'average' refers to underinsurance; in marine insurance, the
word average means ‘loss’.
In marine insurance the concept of underinsurance is referred to as 'underinsurance'!
G7D Excess; deductible; franchise

An excess is an amount that is deducted from each claim and is paid by the insured.
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Some excesses are compulsory, such as the excesses that apply to UK motor insurance
policies for damage to the insured vehicle when young or inexperienced drivers are in
charge of the vehicle.
Most excesses are voluntary and this is the case with commercial policies. This means that
the insured receives some premium reduction for agreeing to carry the excess.
There is a lack of consistency in the market regarding the use of the term deductible.
Historically, a deductible was a large excess – and this remains one of its definitions today.
This would be the case where a commercial organisation agrees to meet the cost of any
claim falling within the policy terms, up to the stated value of the deductible.
Be aware
The two terms 'excess' and 'deductible' sometimes appear to be used interchangeably in
the market.
In general, policies that contain an excess will pay up to the policy limit over and above the
excess; basically building a tower of policy limits above the value of the excess. However,
where the policy refers to a deductible, this amount is deducted from the limits – so unless
the policy wording overrides the basic principle, the insured will never be paid the full policy
limits. Even this usage is not universal, but it serves to distinguish the terms as a general
rule. It is therefore very important to ascertain exactly how the term is being used to identify
the amount of the policy available for the payment of any claims.
If there is underinsurance or any other policy term that limits or reduces a loss, and an
excess or deductible applies to the same loss, the excess or deductible is deducted
last of all.
A franchise operates in the same way as an excess or deductible as it is the first amount of
any claim that the insured must pay themselves. However, it differs once the claim value
exceeds the franchise value. Once this happens, the insurers will pay the whole claim with
the insured not having to pay anything. Franchises are rare in the market these days but it is
important to be aware of them just in case they are seen.
Example 2.6
Policy with limits of US$1m and a Insurers will only ever pay US$900,000 any one loss and the insured
Chapter 2
‘deductible’ of US$100,000. will pay US$100,000 (plus any amount over and above US$1m).
Policy with limits of US$1m and an Insurers will pay up to US$ 1m any one loss and the insured will pay
‘excess’ of US$100,000. US$100,000 plus any amount over and above US$1m.
Policy with limits of US$1m and a If claim exceeds franchise level, insurers will pay up to US$1m and
‘franchise’ of US$100,000. the insured pays nothing (except if claim exceeds US$1m).
If you see the term “From the ground up or FGU” this means that the figures being quoted
(for example estimates for claims) have not taken into account any deductible/franchise or
excess that might be applicable.
H Contribution
There are some situations in which an insured may have in place more than one policy
covering a particular loss or liability. Circumstances may also arise where the policyholder
has insured a risk but the loss, when it happens, is caused by the actions of a third party.
Consequently, not only is the policyholder protected by the insurance, they also have the
potential to recover damages from the third party.
In the first case we need to look at the rules that apply where there is some kind of dual
insurance (under the principle of contribution); in the second we need to see how the
insured’s rights of recovery are passed on to the insurer (the principle of subrogation).
Underlying both these principles is the principle of indemnity, which relates to exact financial
compensation. This means that the insured is not entitled to profit from a claim settlement.
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When we examined the principle of indemnity, we said that when settling a loss, the intention
was to place an insured in the same financial position they enjoyed immediately before
the loss.
We also said that the insured cannot recover more than the financial loss suffered. The
insured can take out as many insurance policies as they wish, provided that there is no
fraudulent intent. But what happens when there is double insurance with more than one valid
policy in force? Can an insured recover under both policies and hence receive more than
they actually lost?
From our study of the principle of indemnity, we know that an insured should not be able to
recover, in total, more than the amount lost by claiming under both policies. The insured can
only recover the total amount of a loss sustained, regardless of the number of policies held.
Let us consider an insured who holds two policies for the same subject-matter (say their
private motor car). If they then make a claim under one of the policies and receive indemnity
from such policy, the other insurer has avoided its financial responsibility to the insured. The
insurer that paid the claim has taken full financial responsibility for the loss. It is this
possibility that gives rise to the principle of contribution, which seeks to share the burden of
the loss fairly among all insurers who cover the loss.
Dual insurance
Refer to
The role of brokers is covered in chapter 8.
There are many situations where dual insurance could exist but it rarely occurs in
commercial insurances due perhaps to the more sophisticated nature of the buyers and the
use of brokers.
The most frequent example of double insurance is a person going on holiday and buying
travel insurance not realising that their household contents insurance could well provide
cover for items such as cameras and sunglasses whilst away from the property.
H1 Contribution condition
Contribution supports the principle of indemnity, and so it exists whether stated in a policy
document or not. However, if there is no specific policy condition, the insured is entitled to
Chapter 2
claim the whole amount from any of the insurers that are liable to pay. This effectively leaves
that insurer to recover appropriate shares of losses paid from the other insurers. Therefore,
insurers customarily include a contribution condition in their policies. This condition restricts
the insurer’s liability to its rateable proportion or rateable share of a loss.
The effect of the condition is to compel the insured to make a claim under each valid policy
for the sum for which each insurer is liable if they wish to receive a full settlement.
H2 Definition of contribution
Contribution is defined as ‘the right of an insurer to call upon others similarly, but not
necessarily equally, liable to the same insured to share the cost of an indemnity payment’.
H3 How contribution arises
common
subject-matter of
insurance
neither policy
contains a common
non-contribution insurable interest
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At common
clause law, the following
requirements must
be satisfied before
contribution
arises:
both must be
policies are insured against
liable for the loss common perils
There is no requirement for the policies to be identical, but there does need to be some
overlap between them.
Common insurable interest
In other words, the insurable interest is the same (owner, user, bailee etc.).
Example 2.7
This principle was established in the case of North British and Mercantile v. Liverpool
and London and Globe (1877), known as the King and Queen Granaries case.
In this case, a merchant had deposited grain at a granary owned by Barnett. By virtue of
the custom of his trade, Barnett had insurable interest in the grain and had insured it
accordingly. The owner had also insured the grain to cover his own interest in it.
The grain was damaged by fire and Barnett’s insurers paid the whole claim. They then
sought to recover from the owner’s insurers. However, it was held that, as the two
insureds’ interests were different, one as bailee (Barnett, the granary owner) and one as
owner (of the grain), contribution did not apply. Barnett’s insurers bore the whole loss.
This raises the question of whether both parties may claim under their policies if the interests
in the same loss are different. In theory, both insureds could recover but, in practice, the
insurance market has reached an agreement to protect itself from paying out twice on the
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same loss.
Common peril
The peril which causes a loss must be common to both policies. Let us consider a situation
where we have two policies: one covering dishonesty and the other covering dishonesty, fire
and burglary. These can be brought into contribution where the loss is due to dishonesty.
However, this is not the case where the loss is due to fire only since this peril is not common
to both policies. The insurer covering fire bears the burden for the loss in these
circumstances.
Common subject-matter
The subject-matter being insured, whether it be a physical object or the risk of being held
liable for something must be the same across both policies.
H4 Application of the principle of contribution

Insurers contribute to a claim on the basis of what is termed a rateable proportion.
Rateable proportion
Rateable proportion is the share of any claim that an insurer pays when two or more insurers
cover the same risk; usually in proportion to the respective sums insured. Two possible ways
of determining the rateable proportion of a claim include:
By sum insured
One method of calculating the rateable proportion of a loss is by apportioning it in line with
the sums insured under each policy. The rateable proportion is calculated using the
formula:
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policy sum insured
× loss
total sums insured
By independent liability
An alternative method for calculating each insurer’s share of a loss is the independent
liability method. This method calculates the amount payable under each policy as if no other
policy existed and the insurer was alone in indemnifying the insured. The loss is then shared
in proportion to the independent liabilities of the two policies.
This method is used where property policies are subject to average or where an individual
loss limit applies within a sum insured. Independent liability is also the method used for
calculating contribution in liability insurances. The formula used is:
independent liability under this policy
× loss
total of independent liabilities under all policies
Example 2.8
This example shows the independent liability method.
Two policies cover a cargo of sugar against water damage.
Policy 1 has sum insured of £100,000 and Policy 2 has sum insured of £30,000.
Damage to the cargo is £60,000 (average will be ignored for this example).
Policy 1 can pay the full £60,000 but Policy 2 can pay a maximum of £30,000.
Policy 1 can pay twice the amount of Policy 2 so will pay 2/3rds of the claim and Policy
2 1/3rd.
Policy 1 pays 2/3rds of £60,000 which is £40,000 and Policy 2 pays £20,000.
Modifications to the principle

There are some situations in which the principle of contribution is modified:
• Non-contribution clauses. Certain policies have what is known as a non-contribution
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clause. This may be worded as follows: ‘This policy shall not apply in respect of any claim
where the insured is entitled to indemnity under any other insurance.’
This means that the policy would not contribute if there was another insurance policy in
force. The courts do not favour such clauses, and in situations where a similar clause
applies to both (or all) policies, they are treated as cancelling each other out. This means
that each insurer would contribute only its rateable proportion.
• More specific insurance clauses. Certain policies include a clause which restricts cover
in situations where a more specific insurance has been arranged. The most common
example of cover being restricted in this way is in a household policy. The reason for this
is that many householders arrange specific insurance for jewellery and other items, and it
is not the intention for both policies to contribute.
• Market agreements. There are many market agreements which operate to smooth the
path of contribution settlements. One example is an Association of British Insurers (ABI)
agreement that applies when there is an overlap between travel, all risks, household and
the personal effects section of a motor policy. The agreement states that insurers will not
insist that the insured claims a proportion from each insurer where the sum involved is
modest, regardless of what the policy conditions actually say.
I Subrogation
We can summarise subrogation as the right of an insurer following payment of a claim,
to take over the insured’s rights to recover payment from a third party responsible for
the loss.
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Subrogation is limited to the amount paid out under the policy.
The insured cannot claim an indemnity payment from an insurer and then also acquire a
further payment from a negligent third party. This would result in a profit to the insured and
would breach the principle of indemnity.
However, the requirement that the insurer must already have indemnified the insured before
pursuing subrogation rights, gives rise to some problems. This is because the insurers would
not have had complete control of proceedings from the date of the loss. Its eventual position
could be severely prejudiced by delay – maybe evidence or witnesses would no longer be
available.
In order to gain this control, insurers invariably include a condition in the policy which gives
them the power to pursue subrogation rights before the claim is paid. The only limitation is
that the insurer cannot recover from a third party before it has actually settled its own
insured’s claim.
Be aware
Do not forget that the concept of indemnity is to place the insured in the financial position
they were in immediately before the loss.
Reinforce
An insurer provides a property policy for a factory which covers fire. A fire breaks out in
the factory and the surveyor advises that the likely cause is some welding work being
done by an external contractor.
The insured could just seek financial compensation from the contractor; however, it is
easier to claim on their property insurance.
They must put the contractor on notice that they will also be pursuing them for damages.
The insurer will be involved in discussions with the contractor but cannot obtain money
from them until the insurance claim has actually been paid. Of course, the contractor could
also have a claim made against them by the insured for any deductible or excess they
have had to pay – this could be quite a significant amount.
I1 Definition of subrogation
Subrogation is the right of one person, having indemnified another under a legal obligation to
do so, to stand in the place of that other and avail themselves of all the rights and remedies
Chapter 2
of that other, whether already enforced or not.
In keeping with the principle of indemnity, insurers are also not entitled to recover more than
they have paid out.
Example 2.9
This is seen in the case of Yorkshire Insurance Co. v. Nisbet Shipping Co. Ltd (1961).
In this case, the insurers made a settlement of £72,000. However, there was a long period
of time between the payment of the claim and the recovery from the third party and there
had been changes in the rates of exchange. Consequently, the insured actually recovered
£127,000. It was held that the insurers were only entitled to £72,000. The insured was
entitled to the balance.
I2 Insurers’ subrogation rights

Let’s consider how the rights that insurers can take over will arise.
I2A Tort
At common law, everyone has a duty to act in a reasonable way towards others. A breach of
this duty is called a tort. The person who has suffered damage or injury is entitled to
compensation.
Examples:
• Someone crashes into the wall of your property in a vehicle and knocks it down.
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• A neighbour lets their property become unsafe and when a chimney collapses it damages
your property.
• Another ship crashes into yours whilst you are moored in port.
You can arrange an insurance policy to cater for each of these events. As well as the
indemnity for the physical damage which insurers provide, the insured has a right (in tort) to
financial compensation from the individuals involved in the wrongdoing. The insurers assume
the rights of the insured and attempt to recover their outlay from the wrongdoer.
Under certain contracts, a breach of contract entitles the aggrieved party to compensation,
regardless of fault. Insurers can assume the benefits of these rights – their rights, however,
can never be better than the insured’s would have been.
Question 2.8
Insurers' rights to claim against a third party having indemnified the insured are
called:
a. Contribution. □
b. Subrogation. □
d. Representation. □
I2B Statute
The Riot Compensation Act 2016 makes provision for types of claims that can be made
against the police and the procedures for making them in relation to property damaged,
destroyed or stolen in the course of riots.
Under the Act, a claim can be made by a property owner, anyone else with a legal interest in
the property (such as a tenant or mortgagee) or by an insurer. It must be made within 43
days of the riot, or a decision by an insurer not to pay all or part of a riot related claim.
Claims made by insurers, having paid out to their clients, must be made within 43 days of the
riot date.
I3 Other rights of insurers to recoup some of their outlay

In some types of insurance, a total loss under the policy will be offered to the insured when
the subject-matter of insurance is not completely destroyed but is perhaps so badly
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damaged that the repair costs will exceed the sum insured.
Of course, when this happens there may be some residual value in the item insured. This is
termed salvage. If the insurer meets the loss in full it is the insurer that is entitled to the
benefit of the salvage value.
Because it is a financial benefit, a question arises as to who has rights to the salvage itself.
The insured has the opportunity to retain the salvage, provided a suitable deduction is made
from the claim payment to take its value into account. The amount needs to be agreed
between the insurer and the insured.
This principle governs the recovery of property. For example, if an insurer pays out a sum as
a total loss for an item of jewellery that has been stolen and it is subsequently recovered, the
insured must be offered the recovered jewellery provided that the full claim payment is
repaid to the insurer.
In an important respect, the rights arising from salvage differ from subrogation rights. When
the insurer retains the salvage, the insurer becomes the owner of it. If, when salvage is sold,
a greater sum is achieved than the insurer originally assumed, this is in order.
Market agreements
There are many situations in which, by virtue of the operation of subrogation, insurers would
be corresponding about money that they would need to claim back from each other.
A limited number of market agreements exist to reduce the correspondence and
administrative costs involved in pursuing frequent subrogation procedures. One example is
the immobile property agreement.
For reference only

In the past, some motor and property insurers operated the immobile property agreement. It
covered impact damage by motor vehicles. Whenever a vehicle collided with a building this
agreement meant that each insurer would contribute towards the loss in the proportions
already agreed. The agreement is now virtually at an end as far as insurers are concerned,
though it still remains in force between certain insurers and local authorities.
I4 Precluded subrogation rights

There are some situations in which insurers are barred from exercising subrogation rights, or
where they agree not to exercise them.
I4A Insured has no rights
The insurer’s right to subrogate relies on the insured having rights against a negligent party
which the insurer takes over, having indemnified the insured. It could be that the insured
entered into a contract with the negligent party which precluded any subrogation rights
arising. These are often known as ‘mutual hold harmless’ agreements where each side
agrees to deal with their own damage and injuries and not claim against the other.
I4B Benefit policies
As we have established, certain policies, such as personal accident policies, are benefit
policies.
These policies are not true policies of indemnity as it is impossible truly to put a person back
in the position they were in before the loss when the loss involves a part of the body. It,
therefore, follows that even if a person negligently causes an accident in which the insured is
injured, the personal accident insurer will have no right of recovery. This is true even if the
insured successfully sues the negligent third party and receives financial compensation for
the injuries.
The insured is entitled to keep both the personal accident benefits and the court award.
Reinforce
Aviation loss of licence insurance exists to replace income for pilots who lose their licence
usually because they fail a medical examination. If this failure comes about because of
Chapter 2
injuries sustained in a car accident, the insurer cannot claim against the responsible driver
in subrogation, however, the injured pilot can, and keep any award made as well as the
insurance payout under their loss of licence policy.
I4C Subrogation waiver

There are circumstances in which insurers agree to waive their rights of subrogation. They
do this through subrogation waiver clauses, which are common in commercial insurances.
These clauses are usually designed to prevent the insurer from pursuing any subrogation
rights it may have against a parent or subsidiary company of the insured.
I4D Negligent fellow employees
Example 2.10
Insurers took the decision not to pursue their recovery rights against negligent fellow
workers as a result of a court case, Lister v. Romford Ice and Cold Storage Ltd (1957).
The details of this case are that a son injured his father in the course of his employment
(they were fellow workers). The insurers paid out for the father’s injuries under the
employer’s liability policy.
They then successfully recovered their outlay from the son (because his father’s injuries
were the result of a lack of reasonable care on his part). There was criticism of the
insurance industry and a general feeling that this was harsh.
Insurers have therefore generally agreed (except in extreme circumstances) not to pursue
For reference only

recovery rights against negligent fellow workers.
Key points

Chapter 2
Contract law
• A valid insurance contract cannot be created without the essential ingredients of offer,
acceptance and consideration.
Consideration
• This is the promise to pay the claim on the part of the insurer and the promise to pay
and payment of the premium on the part of the insured.
Insurable interest
• This means having a relationship with the subject-matter of the contract (be it a
physical thing or a liability) which could lead to financial loss if it is damaged or causes
damage to others.
• Insurable interest does not require ownership.
Duties of disclosure during contract negotiation
• Good faith is a two-way concept whereby both insured and insurers have to disclose
material information to each other.
• The Consumer Insurance (Disclosure and Representations) Act 2012 covers the
obligations of the parties in consumer insurance and the Insurance Act 2015 covers
non-consumer insurance.
For reference only

Cancellation of insurance contracts
• If there is a deliberate breach of the duty of disclosure, then the other party can decide
whether to cancel the contract.
• If there is a lack of a vital ingredient of the contract such as offer or acceptance, then
the contract will never actually exist.
Proximate cause
• Proximate cause is the most powerful operative cause of loss, not necessarily the last
thing to happen.
Indemnity
• This means putting the insured back in the same financial position as they were in prior
to the loss.
• Indemnity is not necessarily done through a cash payment; it could be repair,
replacement or reinstatement.
• Certain policies such as health and accident policies are benefit policies not indemnity
policies as a value cannot be put on a limb or a sense. A scale of benefits is used to
work out the payments made.
Contribution
• Where two or more policies cover the same item for the same risk then they should
share the loss between them in a rateable manner. This is known as contribution.
Subrogation
• Subrogation is the right of the insurers to claim against a responsible third party having
first indemnified the insured.
Question answers
2.1 c. Meeting of minds.
Chapter 2
2.2 d. Insurable interest.
2.3 b. Each renewal is the creation of a new policy of insurance.
2.4 b. The fall from the horse.
2.5 c. The climate related changes.
2.6 c. Indemnity.
2.7 b. £100,000.
This is 1/5th of the claim as the risk is only insured for 4/5ths of its value.
2.8 b. Subrogation.
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Self-test questions
Chapter 2
1. Which option is not an essential of a valid contract?

a. Documentation in English. □
b. Offer. □
d. Acceptance. □
2. What word or phrase is the consideration for an insurance contract?
a. Premium. □
b. Insurable interest. □
c. Offer. □
d. Negotiation. □
3. How can insurable interest be best described?
a. The obligation to pay the premium. □
b. The fact that insurers want to insure the risk. □
□
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c. The legal relationship between an insured and the subject-matter of insurance.
d. The additional money due if a claim is paid late. □

4. Identify an example of good faith from the following options.
a. The insured not paying the premium. □
b. The insured sharing material information with insurers. □
c. The insurers advertising their products. □
d. The broker passing messages on but not providing advice. □
5. If a client answers a question on a proposal form incorrectly to try and obtain a
cheaper premium, what have they done?
a. Misrepresented the risk. □
b. Committed a non-disclosure. □
c. Acted in good faith. □
d. Failed to provide proper consideration. □
6. What is meant by proximate cause?
a. The last thing that happened before the loss. □
b. The first thing that happened in a chain of events leading to the loss. □
c. The cause that created the most damage. □
d. The dominant and operative cause of the loss. □
7. What is meant by indemnity?

a. Paying an agreed amount of compensation for example for loss of body parts. □
Chapter 2
b. Pursuing a responsible third party for their share of any loss. □
c. Returning the insured to the position they were in before the loss. □
d. More than one insurer participating in a risk. □
8. Which of these is not a method whereby insurers can claim money back from other
parties following a loss?
a. Reinsurance. □
b. Subscription. □
c. Subrogation. □
d. Contribution. □
9. An insured will often have to bear the first part of the loss themselves. Which word or
phrase is often used for this amount?
a. Deductible. □
b. Limit of indemnity. □
c. Premium. □
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d. Contribution. □
10. The risk manager of a commercial insured is busy and has not got the time to
investigate everything that they know they should before presenting details of the risk
to insurers. If some information later emerges that should have been shared, what
might insurers suggest that the insured has done?
a. Committed fraud. □
b. Been unprofessional. □
c. Accidentally breached the duty of fair presentation. □
d. Recklessly breached the duty of fair presentation. □
For reference only
Main classes of business
3
written in the London
Chapter 3
Market
outcomes
Introduction
A Marine insurance 3.1
B Non-marine insurance 3.1
C Aviation insurance 3.1
D Reinsurance 5.1, 5.2
Key points
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Question answers
Self-test questions
Learning objectives
• describe the main classes of business written in the London Market;
• describe the main features of the different classes of insurance;
• explain what reinsurance is and why it is used;
• state the main buyers and sellers of reinsurance; and
• describe the main terminology used in reinsurance and explain its meaning.
Introduction
In this chapter, we will be reviewing the key features of the main classes of business written
in the London Insurance Market. More detail of the perils covered in each class can be found
in study text LM2: London Market insurance principles and practices.
We will start with marine insurance, followed by non-marine, aviation and reinsurance.
Interestingly, some specific types of insurance could be described as both marine and non-
marine – as you will see later in the chapter.
Chapter 3
Key terms
Advanced loss of Aviation insurance Business interruption Cargo insurance

profits (ALOP) (BI) insurance
insurance
Contractors all risks Delay in start-up Erection all risks Goods in transit
(CAR) insurance (DSU) insurance (EAR) insurance
Long-tail insurance Marine insurance Mutuals Non-marine
insurance
Motor liability Personal accident Personal illness or Political risks
insurance insurance sickness insurance insurance
Products liability Professional liability Property insurance Public liability
insurance insurance
Reinsurance Short-tail insurance
For reference only

A Marine insurance
Marine insurance as its name suggests generally has some connection with the sea – and
it is fair to say that the sea is a common denominator when looking at the types of insurance
included in this classification.
One word of warning: as we will see, marine insurers are quite prepared to cover risks that
having nothing obvious to do with the sea. This is not done to encroach on the work of their
non-marine colleagues, rather that they have historically been more willing to extend the
boundaries of their natural areas of specialism.
There is additionally an unusual historic practice in the marine market of writing insurance in
situations where the purchaser’s insurable interest is not entirely clear. The lack of clarity
may be around the interest itself or the financial extent of the interest (i.e. how much a vessel
is actually worth).
Insurable interest is required for an insurance policy that is valid in law, so these policies are
known as honour policies (i.e. not enforceable in a court). The term ‘or Policy Proof of
Interest’ (or ‘PPI’) is used to identify them, i.e. the mere possession of a policy is evidence of
the purported insurable interest.
These policies are rare in practice but passing reference is made to them in certain wordings
still used in the market today.
A1 Hull and yacht/recreational vessel insurance

Ships come in various shapes and sizes from the very smallest personal recreational craft
such as a dinghy, up to the largest oil tanker or container vessel. Ignoring their size, they
have broad similarities in shape and design and actually face the same perils when out on
the water.
Chapter 3 Main classes of business written in the London Market 3/3
Sailing vessels ranging from high specification racing vessels, through the fleets which are used for
cruising holidays to the smaller owner operated boats.
Motor vessels ranging from the super vessels owned by the very wealthy, through the cruisers used for
holiday bookings, to the owner operated. Motor vessels can vary widely in the nature of the
propulsion machinery used in them which also varies the nature of the risk.
Inland vessels such as canal boats.
Activity
Visit www.fraseryachts.com to see the different types of vessel that could appear in a
Chapter 3
yacht account.
Commercial vessel insurance also covers a large range of different types of vessels such as:
Cargo vessels Vessels carrying all types of goods ranging from bulk minerals in solid and liquid form,
vehicles, refrigerated goods to containers. These vessels range greatly in size depending on
the shipping routes that they are operating, with smaller vessels used for shorter, coastal
voyages and larger vessels sailing what is known as the deep sea trades.
Cruise/passenger Medium to large vessels used for holiday purposes, often carrying large numbers of
vessels passengers.
Ferries operate in most parts of the world carrying people, their vehicles and some goods
across waterways of varying sizes.
Specialist vessels Vessels such as cable layers, survey ships, drilling ships and heavy lift vessels. These ships
are all constructed to perform certain key tasks which expose them to different risks to other
general cargo-type ships.
The key common element that is covered by any type of marine hull insurance is damage to
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the insured ship which makes this a physical loss or damage type of insurance. This type of
insurance is also known as first party insurance or short-tail insurance.
When referring to insurance, the tail is the time lag between the insurance incepting and the
final closure of any claims under that insurance. Short-tail business has a short time lag, with
claims notified generally quite quickly and being relatively swift to finalise.
These terms are not confined to marine insurance – any physical damage insurance
covering the insured property is first party insurance and is short-tail in nature.
In marine, there is a special term used for physical damage to the insured property which is
‘Particular Average’.
Under most of the policy wordings there is also coverage for the liabilities that arise under
maritime law should the insured vessel collide with another vessel. In the event that this
occurs, maritime law essentially provides that each side has to pay damages to the other
ship that relate to its share of the blame. Each side can then make a claim with their hull
insurers for that amount, in addition to any damage suffered by their own vessel.
Example 3.1
Two ships (1 and 2) collide. After looking at the evidence, they agree that Ship 1 was 60%
to blame and Ship 2 was 40% to blame.
Ship 1 has £100,000 worth of damage to her hull. Ship 2 has to pay £40,000, being 40%
of £100,000.
Ship 2 will make a claim on her hull insurance policy for her collision liabilities.
When the claim is made on the insurance policy, it is important to remember that irrespective
of the insured’s obligations to any other party in law, its claim will still be handled according
to the policy wording. Therefore, the insured will normally have to pay a deductible or
excess, rather than the insurers paying everything.
A1A Builder’s risk insurance

The construction of a vessel (irrespective of her size or eventual use) is an expensive and
lengthy process both for the eventual owner and the builder. Builder’s risk insurance
provides a combined physical damage and liability cover where the insureds can be just the
purchaser/owner or a combination of the purchaser/owner and the build yard. The key
aspects of the insurance are the length of time of the process but also the increasing values
as the building progresses through to completion and handover to the owner.
Activity
Chapter 3
Ask your colleagues if your firm handles marine hull or yacht business. If it does, try to find
out what types of vessels are involved – and whether you specialise in a particular type.
A2 Loss of earnings insurance

If a shipowner cannot use a ship, they cannot earn money from it. If the ship is their sole
source of income then this could be a major problem for them. There are a number of
different reasons why they might not be able to use their ship to generate income, some
within their control and some outside their control. It might be as simple as there is no actual
work for the vessel (which is a pure business risk) or it might be that the vessel has been
damaged or even seized by another party. Therefore, they can purchase insurance covering
their loss of earnings, for instances where they cannot carry passengers, use the vessel for
carrying cargo or hire the vessel out to others.
Typically, the insurance will require some physical damage to have occurred to the vessel
and it is important that this insurance does not cover loss of earnings merely because there
is no work for the vessel to do (this would be a business risk and not insurable).
As we will see in Business interruption insurance on page 3/14, the concept of loss of
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earnings also appears in non-marine insurance where it is generally described as business
interruption (BI) insurance.
In both types of loss of earnings insurance, the way in which the policy limits and deductibles
are expressed differ from physical damage policies. Instead of a financial deductible or
excess, loss of earnings policies generally have waiting periods.
This means that the insured has to wait a period of days from the first day of their inability to
earn – once that period has expired they can claim from their insurer.
Generally, the policy limit is also expressed as a period of days. Of course, there are some
financial provisions within the policy (for example, a maximum indemnity payable per day of
coverage). This figure is calculated using the information provided by the insured concerning
their business – for example their wages bill and any regular (fixed) payments for rent
or rates.
Typical loss of earnings policy

A typical loss of earnings policy will provide for up to 150 days’ indemnity, after a waiting
period of 14 days.
Question 3.1
A ship used for pleasure trips down the Thames is damaged by colliding with Tower
Bridge. The repairs are going to take four months. The shipowner will claim for the
repairs to the ship from their hull insurers but against which other policy can they
claim?
a. Liability insurance purchased by Tower Bridge. □
b. Their loss of earnings policy. □
c. They will claim everything from their hull insurers. □
d. Their reinsurers. □
A3 Cargo and goods in transit insurance

Cargo can be translated as goods; however, in the context of insurance, there is a key
difference between cargo and goods in transit insurance. Cargo insurance is physical
damage insurance for the items being moved around, whereas goods in transit insurance is
primarily liability insurance for the person or organisation moving the items around; it covers
some damage to their own property but mainly their liabilities in case they damage the cargo
in their custody or care.
A3A Cargo insurance
Chapter 3
Even with the rise of road, rail and air cargoes, between 90% and 95% of world trade is still
conducted by sea – resulting in a large demand for marine cargo insurance. Marine cargo
insurers will, in fact, insure journeys by road, rail and air as well as sea.
This insurance covers physical damage to the goods whilst they are on their journey.
However, unlike hull insurance for ships, the standard cargo insurance does not cover any
liabilities for the cargo damaging any persons or their property.
Many modern-day journeys are undertaken using various types of transportation, such as
road, rail and sea, or road and air; therefore, it’s important to ensure that the insurance
remains in force throughout the intended journey and does not stop prematurely. Cargo
insurers generally prefer the items to be moving almost continuously during the transit,
although they recognise that a container, for example, might stop in a port for a couple of
days between being discharged from a smaller local vessel and being loaded onto a larger
vessel for the deep-sea journey.
Cargo insurers do not anticipate insuring storage-type risks as they are of course static in
nature; however, there is a specific type of insurance written in the cargo market which deals
with this very issue – stock throughput insurance.
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A3B Stock throughput insurance
Stock throughput insurance is an end-to-end product which combines a transit policy with
storage policies thus removing the danger of gaps in coverage between a freestanding
storage policy generally written by property/inventory insurers and a transit insurance written
by cargo insurers. They are generally written in the marine market and offer significant
benefits to any client whose business necessitates their goods – both moving and being held
in storage for any given length of time.
Question 3.2
A clothing retailer has a significant supply of clothes that are held in warehouses and
then moved to the various shops they have around the country. What is the most
appropriate type of insurance to purchase to cover these items?
a. Cargo insurance. □
b. Property insurance. □
c. Stock throughput insurance. □
d. Goods in transit insurance. □
A3C Jeweller’s block insurance
As its name suggests, ‘jeweller’s block’ insurance is specifically aimed to cover the jewellery
trade. This was one of the first non-marine areas of insurance introduced into Lloyd’s by
Cuthbert Heath in the late nineteenth century. It is often set up as a package policy covering
many different property and liability type risks and can cover all aspects of the business from
the manufacturing, through trade shows and exhibitions and finally retail risks. It is perhaps
difficult to see how this links in with the marine market and in fact this is one of the classes of
insurance that can just as easily be written in the non-marine market.
There are also transit risks regarding moving the insured items to and from trade shows.
Items moved between various jewellers must be done so in accordance with the practices of
the jewellery trade.
This is a physical loss or damage-type insurance; however, the key elements that are
generally excluded from the loss and damage section are mysterious disappearance and
inventory losses, because of the size and appeal of the items being insured.
A3D Specie insurance
Specie insurance is also a physical loss or damage insurance but the items covered are:
• loose gemstones;
• precious metals, such as gold and silver; and
• valuable documents.
Chapter 3
Documents are not something that we would necessarily think about as having value.
Examples include tickets, vouchers and even cheque books (although less common in the
‘plastic generation’).
In the case of documents, the insurance will cover the cost of reconstructing the documents
should they be lost or damaged (for example, by fire or water).
This is another example of insurance that is written in the cargo market but which could
equally well be written in the non-marine market.
A3E Fine art insurance
Fine art insurance covers paintings, items such as sculptures and those objects which are
generally called 'installations' – which could involve just sound or light rather than a tangible
painting on the wall. As with the examples earlier in this section, this is also a type of
physical loss or damage insurance. One of the elements of cover is not only the cost of
repairing any item that has been damaged but also paying out for depreciation in the value
as a result of having been damaged.
The insureds include museums and private collectors. The insurance will cover both the
For reference only

static risk whilst in the gallery or museum as well as any transit between collections or to
exhibitions.
Since art valuation is quite subjective, it is often the cause of disagreement between the
insurer and insureds; therefore, several expert opinions are required.
Activity
If any fine art is displayed at your office, find out if and where it is insured.
Find out if there have ever been any losses.
A3F Satellite pre-launch insurance

The word ‘satellite’ appears quite out of place here but it is in the right place as the cargo
market does get involved with the insurance of satellites at a point before they are sent into
space. Satellites moving from the manufacturing facility to the rocket launch pad are just
another piece of cargo moving from one place to another, albeit a very expensive and very
delicate one. Cargo insurers cover the satellite for physical loss or damage until the launch
insurer takes over.
When does the launch insurer take over? The wordings of policies differ slightly but the
broad concept is that the satellite pre-launch (cargo) insurer comes off risk when the engines
are intentionally ignited. The launch insurers are in the aviation and space market.
Consider this…
Who will be on risk if the engines accidentally fire and the satellite is destroyed?
Aggregation is an issue for all insurers, i.e. the accumulation of insured items in one place
where they can be exposed to the same perils. This is also the case with satellite pre-launch
insurance where the rockets will often be launching more than one satellite at once, so both
the pre-launch (cargo) insurer and the launch insurer are going to be paying close attention
to the number of satellites they are insuring on any one rocket – just in case something does
go badly wrong.
A3G Cash in transit insurance

Cash in transit is another area of insurance which is also written in the non-marine market as
well as the cargo market. It covers the movement of money between locations.
For example:
• Banks move money between head offices and local branches.
• Banks move money between bank premises and remote Automatic Teller
Machines (ATMs).
• Companies move funds from their premises to their banks.
Chapter 3
This insurance covers loss or damage to the cash, which as you can imagine, is a very
appealing cargo for thieves to target. Underwriters impose various key risk prevention criteria
in the policy terms such as:
• varying routes;
• mixing up the truck crews to avoid the ‘inside job’ (whereby the insured’s personnel are
not entirely honest and pass information about the shipments to outsiders);
• armed truck crews;
• using global positioning satellite (GPS) and other sensors to allow trucks to be tracked if
stolen;
• safety measures whereby paper money is soaked in water and dyes should anyone try
and break into the cases they are carried in, thus rendering the money useless; and
• warranties in respect of (not) leaving vehicles unattended.
A3H Goods in transit insurance
This insurance covers the liability of the carrier in respect of the goods being carried. This
insurance generally does not cover sea carriers as they obtain their liability insurance
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elsewhere using more wide-ranging liability policies. The types of exposure that the policy
covers include not only loss or damage to the goods being carried but also matters such as
the releasing of the cargo at destination to the wrong party.
Liability claims are also called third party claims, as opposed to the physical damage policies
which lead to first party claims.
The parties involved in insurance

In an insurance contract, the insured is the first party, the insurer the second party and
anyone else is a third party. In a liability situation, the policy is being triggered by a claim
on the insured by someone else, which is why they are called third party claims.
The insurer considers the following questions when considering a goods in transit risk:
• What is the nature of the insured’s business?
• What controls need to be in place to ensure the insured cargo is well looked after during
the transit?
• Does the insured have its own fleet of vehicles which are well maintained?
A4 War and strikes insurance

Both war and strikes (which actually includes terrorism in the main wordings) are excluded
from the main hull, cargo and marine liability policies. However, marine war and strikes
insurance is fairly freely available within the London Market, but the main market wordings
are not quite as broad as the exclusions they are replacing.
War insurance covers war and civil war type risks, together with captures and seizures and
the damage that might be caused by abandoned mines or similar ancient weapons. Piracy is
specifically not included as a war risk in the main London Market wordings and is covered as
a main peril in the hull wordings and in the widest of the cargo wordings. However, hull
insurers will often move the peril under war insurance to keep all similar risks together.
Strikes insurance covers both strikes and damage caused by terrorists or those acting from
a political or religious motive.
Definition of a strike
A strike is defined in English law as ‘a concerted stoppage of work’, which requires
planning and action. It is possible to have industrial action short of a strike such as
refusing to work overtime, which if you are not contractually obliged to work then cannot
be a stoppage of work.
One of the reasons that this kind of insurance is freely available is that marine risks are
generally expected to be mobile and hence able to move out of danger should it arise. In
practice, insurers use cancellation wordings to allow them to cancel and immediately
Chapter 3
reinstate the policy as required. They take the opportunity to amend the policy terms and
conditions, imposing increased premiums for any voyages into areas considered at any time
to be more dangerous.
The areas of the world where these additional premiums have to be paid vary according to
the prevalent political situation.
Activity
Which areas of the world do you think insurers might consider more dangerous at the
moment – from a marine war perspective? Ask your senior colleagues for their opinion.
A5 Marine liabilities
Just as a shipowner can purchase insurance against physical loss or damage to their ships,
they should also consider purchasing insurance in case they incur any legal liabilities by
injuring someone else, or their property. This is called 'third-party' insurance because there
will be someone other than the insured involved in any claim.
This is also an example of long-tail insurance where there can be a significant time period
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between the insurance period, and the final closure of claims made on that insurance.
As we saw earlier, hull insurers include an element of liability insurance in their policy, i.e.
liability arising from a collision with another vessel. However, this coverage is quite restricted
and hence other liability insurance would be a prudent purchase.
We will now look at some examples of the types of liabilities that marine-related industries
can incur. Note, however, that the list is not exhaustive.
Vessel owners and operators should purchase insurance in relation to their liabilities for:
• Injury or death of crew.
• Injury or death of other visitors to the vessel who are not crew, for example, the port
chaplain.
• Pollution caused by escape of cargo, waste water or the vessel’s fuel.
• Damage to the cargo being carried.
• Damage done to other people’s property (such as docks, lighthouses and buoys) by the
vessel colliding with them.
Collision liability
Contrast this with the liability insurance available under the hull policy – this is for colliding/
making contact with another ship (or considered as a ship in law) only.
• Removing the wreck after an incident.

• Damage caused to the vessel if they have hired (or chartered) the vessel from the owner.
Vessel-owners or operators are not the only parties involved in the maritime business who
can incur liabilities to others. Other parties which should also consider purchasing insurance
to protect themselves from the financial consequences of incurring liabilities to others are:
Port authorities • Damage to vessels caused by the harbour not free of obstructions or the
docks not secure.
• Damage to vessels caused by shore cranes.
• Damage caused by port authority tug boats (used for towing larger ships in
the confines of a port).
• Liability to cargo owners if they release the cargo from their care to the
wrong parties.
• Liability to neighbouring properties for pollution arising from liquids or dust.
• Liability to vessels for engine damage if the port authority provided
substandard bunkers (ships fuel is known as bunkers).
Chapter 3
Shipbuilders/ship repairers • Liability for not repairing or building a vessel properly.
• Liability for damage to other vessels following an accident such as a fire or
explosion in the shipyard.
• Liability for injuries to personnel or visitors.
Marina owners • Liability for pleasure vessels damaged while in the marina.
• Liability for individuals injured whilst on marina property.
• Liability for any injury caused by food or drink if the marina has a bar or
catering facilities.
• Liability for providing fuel or stores which are not of the correct standard.
Particularly for those land-based businesses such as marinas and shipyards, the liability for
their employees will normally be covered by a standard non-marine employers’ liability policy
and there is nothing particularly maritime about the nature of the coverage, other than the
insurers need to know the nature of the business.
Question 3.3
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A yacht marina provides fuel to both those who moor there and to visiting vessels. If
damage is caused to the vessels by the fuel and the marina is sued, which marine
insurance policy should respond?
a. Liability. □
b. Hull. □
c. Property. □
d. Personal accident. □
A6 Political risks insurance (PRI)
The rapid globalisation of financial markets has opened significant avenues for multinational
banks, commodities traders and many other companies transacting business overseas.
Notwithstanding the massive opportunities gained by operating in emerging markets across
the globe, there are, nonetheless, inherent and highly unpredictable political perils which can
have a significant impact on a given corporation’s assets, investments and trades in second
and third-world countries.
PRI offers one of the means for investors and businesses to mitigate and manage the risks
arising from the (in)actions of, or the restrictions imposed by, hostile or unconstitutional
governmental actions and in doing so helps foster a more stable environment for trade and
investments into emerging markets and thus can help to open new and to bolster existing
channels of finance.
The portfolio of subclasses of political risks insurance offered within the market is extremely
varied. It includes asset risks, such as CEND (confiscation, expropriation, nationalisation and
deprivation), CCP (central counterparty), and contract frustration risks, such as non-payment
and non-delivery by public and private obligors, exchange transfer, non-honouring of
documentary letters of credit and wrong calling of bonds. In addition, the PRI market has
successfully catered for war on land and political violence alongside the other perils
aforementioned.
It offers the trade finance banks a realistic alternative to syndicating (i.e. sharing out or
spreading) exposure to their direct competitors. It also offers an alternative for exporters to
using state-funded Export Credit Schemes, which can sometimes be very slow and/or
bureaucratic. Export Credit Schemes also have very strict acceptance principles, often
relating to the amount of the goods produced emanating from the host country. Private
market insurance, of course, does not have any of these restrictions. Political risks insurance
also offers a high level of capacity in key markets, such as Africa, which it would now be
impossible to effectively find elsewhere. The presence of political risks insurance can also
help a customer to obtain backing for their project from trade-finance banks on more slightly
preferential terms.
Chapter 3
On the Web
Use this link to access a political risk map:
www.marsh.com/us/services/political-risk/insights/political-risk-map-2021-middle-east-and-
north-africa.html.html
A7 Offshore energy insurance

In this section, we will look at that part of the energy market that developed from the marine
market, in relation to the location and extraction of oil and gas from under the seabed.
Refer to
Construction insurance is covered in Construction insurance on page 3/12
The offshore energy insurance market is also known as the ‘upstream’ area of the business,
as contrasted with the onshore energy market which is generally termed ‘downstream’. In the
For reference only

middle is the part not unsurprisingly called ‘midstream’, which also tends to be insured in the
onshore market.
Be aware
The term upstream is used to define any part of the industry involved with the extraction of
oil and gas and therefore you can have upstream risks on land – much oil/gas drilling is
done onshore as well as offshore.
The offshore energy business can be divided into three distinct phases of operation (in
relation to the client’s business):
Exploration phase This is where the oil and gas is searched for using mobile drilling rigs which can be
moved from location to location as required. The risks in this phase are both
physical in nature to both the rig and the surrounding area (weather-related for
example) and the liabilities to people, other property and for pollution should there
be a blowout (an uncontrolled flow of oil or gas to the surface).
Construction phase Once a viable source of oil or gas is located, a more permanent rig has to be
constructed to remain on-site. This insurance will cover the whole construction
period, often involving multiple locations around the world, the bringing together of
all the parts and the on-site fitting. As with the exploration phase, this type of
insurance covers both physical damage and liability risks.
Operational phase Once a permanent rig has been constructed the rig moves into the ‘business as
usual’ phase – and together with the physical damage and liability risks already
seen in the exploration and construction phase, additional risks such as war and
terrorism have to be considered.
Windstorm risks
One risk that all aspects of the offshore energy insurance market faces is windstorm. The
2005 and 2008 hurricanes that went through the Gulf of Mexico oilfields caused
unprecedented damage. The key problem was mobility or rather lack of mobility of the
items insured.
Activity
Find out if your company was involved in any of the energy losses following the 2005 and
2008 hurricanes. Are any of the claim files still open?
The offshore energy market avoided substantial losses following the 2017 hurricanes
(Harvey, Irma and Maria) although the onshore market did suffer large losses.
Read this article for a perspective on the energy market:
www.wtwco.com/en-US/Insights/2022/04/energy-market-review-2022
Chapter 3
B Non-marine insurance
In this section, we will look at the classes of business written in the London Market that can
be grouped together as non-marine. We will not be re-visiting those items (such as fine art)
that can be written in both the marine and non-marine markets.
Just as with the marine classes, property/physical damage can be called first party and short
tail, and the liability classes can be called third party or long tail.
B1 Property insurance (including construction and

onshore energy)
In this section, we will explore those areas of insurance which are loosely grouped as
property, but in reality, cover several different areas.
B1A Property insurance
As the name suggests, this is physical damage insurance for buildings, which can include:
• office buildings;
For reference only

• industrial buildings (including factories and warehouses);
• public buildings (including theatres and libraries);
• retail units of all sizes;
• agricultural buildings; and
• domestic buildings, i.e. houses.
Buildings vary dramatically in their construction and use; these factors impact on an insurer’s
consideration of the risk. Whatever their variations, there are several common threads in
terms of the insurance that is available from the property market. As with marine cargo, there
are some additional types of insurance that also appear in this market which do not
obviously ‘fit’ there.
The basic type of property insurance for industrial buildings can also cover machinery,
fixtures and fittings within any building – as well as the raw materials before they go into the
manufacturing process together with the finished product before shipment.
In a property policy, the method by which the insured can be indemnified includes the option
for reinstatement, which is not found in marine policies generally. Reinstatement means to
re-build the property that has been damaged; the key here is to ensure that the sum insured
is adequate to cover the costs of any reinstatement that might be required, taking into
account that it might take some time (and that inflation may push material and labour costs
up during that period). Claims under property policies are examined further in study
text LM2.
There are various other types of insurance that fall within the general definition of property
but should be reviewed separately, as follows:
Stock insurance
This is a physical damage insurance covering stock at the insured’s premises. Regular
declarations of stock levels must be made to the insurer so that in the event of a claim there
is no danger of underinsurance.
Theft insurance
This deals with theft involving forcible entry to the property, but generally does not cover any
claims where forcible entry is not apparent. This is to avoid any claims for losses arising from
collusion involving someone working for the insured.
Glass insurance
As the name suggests this insurance covers specifically the glass elements of a building. It
also deals with aspects such as boarding up properties for security purposes after an
incident and the replacement of specific items such as inbuilt alarms and lettering on
the glass.
Goods in transit insurance
Goods in transit insurance was covered in Goods in transit insurance on page 3/7, under
‘marine’ and will not be reviewed again here. It is, however, important to appreciate that this
can be a non-marine risk as often as it is a marine risk.
Chapter 3
B1B Pecuniary insurances

These insurances are covering monetary loss rather than physical loss or damage and
insurance can be purchased for losses arising from a wide range of internal and external
perils.
Money insurance applies to the risks of money and valuable documents such as tickets and
vouchers which are the responsibility of the insured anywhere in the world. As with theft
insurance, money insurance does not respond if there is any suggestion of an ‘inside job’.
Additionally, there will be requirements for vehicles to remain attended at all times.
Money insurance
This insurance is much the same as ‘cash in transit’ insurance written in the marine
market – see Cash in transit insurance on page 3/7.
Fidelity guarantee insurance responds to fraudulent acts committed during the policy
period. (Note that fidelity means faith or trust.)
One type of activity that it responds to is an employee in a position of responsibility diverting
For reference only

funds into their own account. The insured can decide whether to buy a policy that covers all
their employees, just certain named ones or use named positions rather than named
personnel. Unusually, these policies can be triggered by the discovery of the fraudulent
activity some time after it was actually undertaken which means that a policy could be
notified of a claim some time after expiry (also known as the ‘discovery period’).
Business interruption is also a type of pecuniary insurance but is reviewed separately in
Business interruption insurance on page 3/14.
B1C Construction insurance
The construction of a building, as with a vessel or an oil rig, is a lengthy process. It generally
involves several different parties, ranging from those responsible for preparing the
foundations, through to the specialist companies (such as crane operators) involved in
different areas of the build and fitting of the building.
On a typical building site, there is a main contractor who engages specialist sub-contractors
to perform specific tasks and each party could and should obtain their own insurance.
However, it also makes sense for central policies to be obtained which have a number of the
parties involved as insureds. This serves to prevent gaps in coverage should anything go
wrong. These policies commence their cover at the start of the work and terminate once the
project (or a discrete element of it) is handed over.
If required, maintenance periods (which cover the period immediately after handover of the
project (or part of the project) can be built into the policy cover usually for twelve months.
This allows for the ‘snagging element’ of any construction to be dealt with under the main
construction policies, whereby faults that appear in the first few months are identified and
repaired.
Contractors all risks (CAR) and Erection all risks (EAR) policies are a combination of
physical damage and liability cover. CAR policies are usually purchased by the main
contractor on behalf of other sub-contractors and EAR policies are purchased by the
contractor responsible for putting up or installing machinery, or steel structures of any type.
Two types of liability cover available

The types of liability that must be covered under these policies are: damage to third party
property; and bodily injury to third parties.
Activity
Look around where your office is based and consider the risks within any constructions
projects you can see.
Chapter 3
B1D Onshore energy insurance
As we saw in Offshore energy insurance on page 3/10, midstream and onshore/downstream
energy insurance covers those elements of the oil and gas industry that come after it has
been successfully located and recovered from the depths of the earth.
Midstream insurance covers pipelines and downstream covers the refining and
petrochemical processing elements of the business. It is important to appreciate, however,
that the onshore energy business does not solely incorporate elements related to oil and
gas, but can also include mining, power generation risks (including nuclear power stations)
as well as renewable energy sources such as hydroelectric power, wind farms, solar energy
and biofuel plants.
In terms of the coverage available, it is broadly similar to a construction or property risk,
taking into account the specialist nature of the property insured and the issues relating to the
construction of such facilities. Additionally, it is prudent to obtain liability insurances
(discussed in more detail in Non-marine liabilities (also known as casualty) on page 3/15).
B1E Cyber insurance
For reference only

With our digitally connected world, there is the risk of losses caused by the use of networks
to access online systems and information. This can lead to a number of different problems
and insurance solutions are being developed to meet these needs.
Issues can include:
• Errors and omissions/professional indemnity – where your product or services fail in
some way.
• Network security failures – where a business can be compromised in some way, leading
to physical damage or business interruption and also to situations where data is stolen or
the business is held to ransom.
• Privacy breaches – where customer data is stolen, either electronically or by the physical
theft/loss of company devices.
Cyber policies can cover the following types of exposure:
• Business interruption.
• Reputation protection (for example, by dealing with the costs and logistics of
communicating with customers whose data might have been taken).
• Payment of ransoms where extortion is involved.
• Practical support, such as crisis management personnel, liaison with regulators, legal
advice.
• Physical damage to systems.
• Regulatory investigations (for example, in relation to a breach of GDPR requirements).
• Directors and officers liability.
• Contingent business interruption (where your business is stopped because one of your
suppliers has been hacked).
Activity
Research some cyber incidents such as the Norsk Hydro hack or the attack by drug
smugglers on the Port of Antwerp:
www.wired.co.uk/article/norsk-hydro-cyber-attack
www.bbc.co.uk/news/world-europe-24539417
Use this link to find out more about large cyber breaches: informationisbeautiful.net/
visualizations/worlds-biggest-data-breaches-hacks.
Chapter 3
Look at the Lloyd's report on emerging cyber risks to industrial control systems:
www.lloyds.com/news-and-insights/risk-reports/library/icsreport
Find out what involvement your business has with cyber insurance. Is it a new product it is
are offering or something it is trying to exclude?
B2 Business interruption insurance

As we saw in Loss of earnings insurance on page 3/4, if a vessel is damaged and cannot be
used to generate income, then the insured could lose money. The same is true for property-
related risks and business interruption (BI) insurance serves to replace lost income after a
waiting period (usually expressed in days as per the marine ‘loss of earnings’ policy).
Basic BI insurance requires physical loss or damage to the insured property which triggers
the shutdown and consequent loss of income.
It is always possible, however, that the shutdown of a factory or other facility may have been
caused by a problem located outside the actual property itself. Two examples of this situation
are as follows:
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• A supplier of raw materials fails to provide supplies to a factory. Although some of the raw
material has been stockpiled, once it has been used up the factory has to stop work.
• A power supplier’s premises are damaged which cuts off power supplies to the insured’s
factory.
In these cases, a policy which requires ‘physical damage to own property’ in order to trigger
the BI section would be of little or no use. A separate policy or extension of coverage known
as a ‘contingent business interruption’ has been developed which requires evidence of a link
between damage to an external party and the insured shutdown, but not damage to owned
property.
Activity
Do some research into the issues that have been identified in relation to BI losses related
to COVID-19 and speak to your colleagues to find out what impact it might have had on
your organisation.
Use these links to get you started:
www.lloyds.com
www.fca.org.uk/firms/business-interruption-insurance
Question 3.4
A metal smelter maintains a reserve of raw material which will cover five days'
production. Their suppliers call them to advise that no more will be delivered for at
least ten days and there are no other suppliers. The factory manager knows they will
have to shut the factory down in five days' time and does not know when they will be
able to restart. Which insurers should they notify?
a. Property. □
□
Chapter 3
b. Business interruption.
c. Liability. □
d. Contingent business interruption. □
B2A Advanced loss of profits (ALOP) and delay in start-up (DSU)
insurance
In all types of major construction projects, time is of the essence. As a result, there are
penalty clauses in the various contracts and sub-contracts which cause significant financial
pain if invoked. They are invoked if the project overruns either an interim timeline or a final
delivery date – for a number of reasons (generally, of course, those within the control of the
contractor). However, alongside the contractual penalties imposed on contractors, there are
the real risks of loss of profit and increased debt servicing costs should the project not be
completed on time.
Loss of profit and debt servicing cost provisions and the costs of working overtime (known as
increased costs of working) can be insured and are found both in marine and non-marine
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insurances.
Marine Found in a type of cargo insurance known as 'project cargo'. In these

policies, the items being shipped tend to be large pieces of equipment
destined for power plants and similar projects. Should they not arrive on
time the knock-on effect to the project will be a considerable delay.
Additionally, the items concerned tend not to be off-the-shelf items so
replacing lost or damaged items will take time.
The policy will be in two parts, the first, a standard cargo policy and the
second: 'delay in start up' (DSU) which covers the financial impact of the
project not starting up on time.
Non-marine Often purchased as an additional cover by those companies buying

CAR/EAR cover. It works in the same way as the marine-related policy
described above, in that it is triggered by delays incurred because of
physical damage occurring to assets which delays the build process.
B3 Non-marine liabilities (also known as casualty)

As we saw in Marine liabilities on page 3/8, as well as purchasing physical damage
insurance for loss or damage to owned property, it is prudent to consider obtaining insurance
to cover any legal liabilities which might be incurred during the operation of a business.
In chapter 1 we reviewed the types of insurance that are compulsory in the UK, and although
it may not have appeared obvious at the time, they relate to liability insurances rather than
physical damage insurances.
Reinforce
If you cannot recall the types of insurance that are compulsory in the UK, re-visit
Compulsory insurance on page 1/18.
There are various types of liability insurance available in the London Market and we will
consider a few of them here:
• Employers’ liability – this is a compulsory form of insurance in the UK and its US
equivalent, known as ‘workers’ compensation’, is also compulsory. This insurance covers
the employer should an employee become injured during their employment and make a
claim against their employer. There is a specialist marine version of this policy known as
‘maritime employers’ liability’ and cover for ship’s crew can be provided by the P & I
insurers.
• Public liability – this insurance covers any party who is liable for loss or damage caused
Chapter 3
to members of the public visiting their premises, or for any loss or damage caused by an
employee to a client or member of the public.
Examples of typical insureds are:
– shops (if you trip and fall on a wet floor that has not been cleaned up);
– restaurants (if you get food poisoning);
– nightclubs;
– riding schools – this is a compulsory form of insurance in the UK.
Any insured could obtain a public liability policy to cover their activities, however, the
coverage provided in common with other policies may also be subject to some
exclusions.
• Professional liability – this insurance covers professionals such as lawyers, doctors,
accountants, stockbrokers against the risk of a claim being made against them for
incorrect advice or negligent activity. In relation to this type of risk, the claim would be
made against them for anything which amounted to a breach of their professional duty,
with the claimant having suffered perhaps financial loss or even physical damage of
some type.
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Medical malpractice insurance
In relation to the medical profession this is also known as medical malpractice insurance.
In this area, the types of damage likely to be suffered are those caused by a badly
performed operation or difficult birth causing injury or death to either mother or child.
Certain types of professional negligence are compulsory in the UK (for example for
lawyers) in order to maintain their practising licences.
• Motor liability – motor insurance for standard individual motor risks is not generally
written in the London Market – rather by different divisions of the insurance companies or
by service companies linked to the syndicates. Basic motor liability insurance is also a
compulsory insurance in the UK and covers only liability to a third party for loss or
damage to them or to their property.
• General liability – this insurance can cover a number of different areas of liability and
can be purchased either as a freestanding policy or in addition to a physical damage or
construction type policy. Rather than covering a specific type of liability such as public or
professional, this policy seeks to provide rather more general cover that will respond as
long as the insured has a legal liability.
Advertising injury
The types of liability that these policies will pick up include advertising injury (which
includes not being hit on the head with a hoarding) which is a claim that you have
slandered someone else by writing something about them which was untrue.
• Products liability – as the name suggests this insurance relates to a product causing
physical damage to something or injury to someone (personal or bodily injury). The
insurance is not, however, only available to the manufacturer of a product but to any party
in the manufacture, sales, supply and distribution chain.
In reality, when a party is injured or has their property damaged by a product, they may
choose to claim against a number of different parties in the supply chain, including the
retailer and the manufacturer and therefore there may be a number of different policies
interested in the same claim.
Activity
Open your store cupboard at home and choose a packaged food product. Think about
how many different organisations might have been involved from the raw materials
through to your buying it and bringing it home.
Write some notes about the various parties and where they fit in the chain.
Please note that in relation to US business the term ‘casualty business’ is often used to
mean non-marine liability insurance of all types.
Chapter 3
Activity
Research some of the new forms of liability insurance that are being written in the London
Market, for example the following instance of active shooter protection:
www.beazley.com/documents/Factsheets/beazley-pcg-activeshooter-factsheet.pdf
B4 Bloodstock and livestock insurance

This is not pet insurance – which is not generally written directly in the London Market, but
insurance on animals that are used for business.
• Bloodstock means horses, generally racehorses and other types of competition horses
such as show-jumpers.
• Livestock can cover many other animals such as alpacas, cows, sheep, llamas, camels
and even fish farms.
The main risk is the death or illness of the animal. This basic cover can be extended to cover
infertility of a stallion or a mare when put to stud following their retirement and any
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prospective foals that are due to be born.
B5 Contingency insurance
Contingency is the underlying concept of insurance in that it requires a fortuity; however,
there is a specific group of insurances known as contingency insurance.
This includes event cancellation, weather-related insurances, prize indemnity, death and
disgrace and over-redemption.
Event cancellation This insurance will generally cover concert or event promoters against the risk of an
event having to be cancelled because of performer illness. When considering the
risk, the insurer will take into account the health of the performer, the nature of the
concert tour or event being insured and the options for re-arranging concerts if
required, so as to minimise the losses.
Weather-related Such as rain washing out Wimbledon, or cricket test matches. These insurances will
insurances usually require significant rainfall.
Prize indemnity This insurance covers against the risk of a golfer sinking a ‘hole in one’ at a
nominated hole at a certain tournament whereby they might win a cash prize or a
high-performance car. This insurance is essentially statistical in nature and the
underwriter will try to calculate the odds of the incident occurring. As a precaution,
there will also be an independent adjudicator on site during the event to ensure no
odd behaviour (cheating).
Death and disgrace This insurance covers organisations which are faced with additional costs to reshoot
advertising campaigns either because the famous person who is fronting an
advertising campaign is found to be less perfect than previously believed (having
committed a form of indiscretion – such as adultery – or crime such as drug-taking)
or in fact suddenly dies – perhaps entirely by accident – which is more usually the
case with sports personalities.
Over-redemption This insurance is linked to offers and promotions on items such as crisp packets
where members of the public can send coupons off and receive items such as books
for their school. The crisp manufacturer is operating the promotion to increase its
sales; however, it does not want to find itself in the situation where the promotion is
so popular that it costs more money than the increased sales generated.
Here, the insured and insurer work out the likely response rate that is expected given
historic information and the insurer generally provides insurance that will be triggered
by a response in excess of that which is expected.
On the Web
Look at the link below and find out about the concert cancellation claim for The Rolling
Stones:
www.musiclawupdates.com/?p=6044
or this one about a claim by Kanye West:
bit.ly/2Pl3yvb (registration required)
Chapter 3
On the Web
Look at this Independent article and see how Hoover’s brand was damaged by a
promotion that went wrong.
https://bit.ly/3RD1i23
B6 Personal accident insurance

A number of different insurances written in the London Market fall under the general title of
‘personal accident’ and we will look at some of these in overview here:
• Personal accident – as the name suggests, this insurance is triggered by an accident.
However, it is not a policy of indemnity as it is not possible to put a price on the loss of a
hand, a leg, sight or hearing. Instead, the policy has a schedule of benefits which are paid
out should the policy be triggered.
There are a number of options as to the payouts: weekly or monthly benefits plus the
potential for lump sums should the injured person suffer permanent or temporary total
disablement.
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A lump sum payable on death is another feature that can be built into these policies.
This type of insurance can be taken out for sports people who run a far higher risk of
being unable to continue with their chosen career should they suffer injury. Insurers seek
to contain the risk by putting restrictions or outright bans in the policy around activities
such as recreational motorbike riding.
• Personal illness or sickness insurance – in contrast with the previous insurance this
type is triggered by sickness as well as an accident or injury. This insurance is often also
known as accident, sickness and unemployment cover (ASU).
• Death in service – this insurance is generally purchased by employers to cover the
situation where an employee dies whilst in their employment and the employer has to pay
(in accordance with the employment contract) ‘death in service benefit’ to the employee’s
beneficiary. This generally amounts to a lump sum payment of between two and four
times’ salary. This type of insurance is not generally written in Lloyd’s although there is a
term life market which provides life cover for a short policy period of up to a maximum of
25 years.
B7 Kidnap and ransom insurance

Kidnap is the capturing of a person and then demanding payment or a ransom for their
release. This is quite a common occurrence in certain parts of the world and companies and
individuals will take out this insurance, either for themselves or for key personnel.
payment for
medical expenses
for the captured
person once
released
Chapter 3
The insurance
covers a number
of key areas:
provision
of a specialist
negotiation team
payment of
to assist the insured
the ransom itself
family/company
during the
incident
One of the main issues with this type of insurance is that its existence should be kept secret
by all concerned and even within the insurers and brokers only very few personnel know the
actual identities of the insured persons. As you can imagine, making public this type of
insurance puts the persons concerned at even greater risk than they would otherwise be –
from those keen to make money out of them.
For reference only

Kidnap and ransom insurance is also written in the marine insurance market as a specialist
vehicle for the payment of ransoms demanded by pirates seizing ships and cargoes.
B8 Malicious product tamper, extortion and product recall

insurance
Imagine the horror of a person in the head office of a major supermarket chain who receives
a phone call or a letter telling them that some food at one of their shops has been tampered
with. A number of things will be running through their minds, such as:
• removing the potentially affected items off the shelves as quickly as possible;
• replacing that stock; and
• maintaining brand loyalty should news of the tampering incident leak out.
The actions that are taken after the receipt of the message all cost money, which is where
this insurance will assist the insured. In the case of extortion, the person or organisation
sending the message demands money in exchange for:
• revealing information about the contamination; and/or
• keeping quiet about the contamination story.
Be aware
Extortion is, in fact, another word for blackmail.
If a retailer identifies a safety issue with one of its products (e.g. a supermarket discovers
glass in one of its food lines). Warnings have to be sent out to the general public, stock has
to be removed and destroyed and the brand image maintained as far as possible. In
addition, a regulator might order a recall of products because of a suspected problem. The
challenge here is that there might not have been any loss or damage, but the insured is
working to maintain their reputation.
Activity
Keep an eye on the newspapers and watch for advertisements recalling any type of
product – food and children’s toys are the most common. A good example in 2013 was the
horsemeat in processed food scandal.
For example, here is a link for a recall of products by Tesco:
www.tesco.com/productrecall/
Look carefully at the wording of the advertisements and consider whether your view of the
brand is impacted in any way.
Chapter 3
Use this link to check out the Food Standards Agency alert list:
www.food.gov.uk/news-alerts/search/alerts
B9 Intellectual property insurance

Intellectual property is the technical term for the rights that companies and individuals have
to their work or their inventions. Trademarks can also be protected in the same way and
authors seek to protect the copyright of their books.
Logos will also be protected and companies will challenge others who they believe are
causing them problems by using similar names or logos in their business. The problem
occurs when brand names actually become used in English as normal words.
Consider this…
If you are doing your housework, do you decide to ‘vacuum’ the room or to ‘hoover’ the
room? Hoover is a brand name; however, it has been around for so long, it has become
the verb we use for the actual activity – we rarely ‘Dyson’ or ‘Miele’ a room, which
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suggests that those brand names, among others, have not become so much a part of our
consciousness.
Inventors patent their inventions legally to protect their rights to use them and more
importantly make money from them. Should someone try and interfere with your rights then
you can sue them but this costs money.
Intellectual property insurance primarily covers the legal costs of defending an action against
your intellectual property, or alternatively if you are alleged to have interfered with someone
else’s intellectual property rights.
Question 3.5
A charity is holding a black-tie ball to raise funds and one of the activities will be a
gaming table where there will be the chance of winning a Ferrari if the correct
combination of dice is thrown. The local Ferrari garage will supply the car but they
are not willing to donate it. What type of insurance should the charity purchase to
cover the risk of someone winning the car?
a. Motor. □
b. Intellectual property. □
c. Prize indemnity. □
d. Liability. □
C Aviation insurance
In this section, we will look at the different types of risk that can be insured in this part of the
market. What we will see is that the basic concepts of physical damage and liability
insurances exist in this area, just as they do in marine and non-marine insurances.
C1 Physical damage insurance

There are different types of aircraft and flying objects which present different risks to the
insurers, as follows:
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Private pleasure fixed wing aircraft These can vary in size depending on the spending power of the owner
and their propulsion will vary from jets to propellers. The basic
construction is broadly the same, although the materials vary from the
older aircraft to the more modern together with the number of electronics
on board. In this way, a private pleasure aircraft has much in common
with a yacht.
The risks that the insurer considers for any aircraft fall into the three
categories of taking off, landing and flying. The insurer considers the
nature of the construction of the aircraft, the propulsion and the
experience of the pilots – as well as the journeys that will be made.
Commercial fixed wing aircraft As with private aircraft, commercial aircraft vary hugely in their size,
propulsion and amount of electronics on board. The challenge for the
insurer, as with any class of insurance, is to remain up-to-date with the
modern developments in construction and design so as to consider any
changes in the nature of the risk that are presented to the market.
Rotary aircraft Helicopters can fall into both the private ownership and commercial
category and present different risks given the nature of the technology.
Perhaps most obviously is the fact that if the engines fail, they do not
glide as well as fixed wing aircraft (although they do not necessarily fall
For reference only

directly to earth either). Helicopters are often used in difficult terrain –
perhaps to support construction or drilling projects and are therefore
worked harder than an equivalent fixed wing aircraft.
Gliders hese look like fixed wing aircraft but have no independent means of
propulsion; gliders can suffer the same types of physical damage to the
structure as a fixed wing aircraft or a helicopter.
Microlights These are essentially hang-gliders with the addition of small engines to
power them, rather than relying on the prevailing wind; they are used in a
popular leisure activity. The wings are made of thin material stretched
over a frame and are therefore liable to damage easily on impact and the
engine is relatively unprotected to ensure that weight is minimised.
Hot air balloons The traditional concept of a hot air canopy with a basket underneath has
been taken to extremes in recent years with increasingly extraordinary
shapes invented (whilst still maintaining the concept of the hot air canopy
over a basket and a burner to keep the air hot). The canopy is relatively
fragile and should the balloon descend too rapidly, it is the basket and the
burners that will impact first and suffer the most damage.
Unmanned aerial vehicles or drones These can vary from toys to large, powerful devices which are used for
surveys and aerial photography.
On the Web
Use this link to discover more about drone insurance:
www.coverdrone.com/#close_newsletter
These types of aircraft/flying machines can be insured for physical damage. Insurers need to
be aware of the use of the aircraft and the locations in which they will be operating. Just as
with other types of physical damage insurance, aviation insurers will not cover wear and
tear losses.
C2 Aviation liabilities
As we have seen already, organisations and individuals can incur legal liabilities should they
cause loss or damage to someone else or their property. The coverage given under the
standard aviation policies for airlines falls into three main categories of passengers, third
parties other than passengers and products-related liabilities.
Passengers As long as the injury occurred either whilst boarding, disembarking or on the plane.
Therefore, if an airline passenger falls over in the airport’s duty-free shop, it is likely to be
the responsibility of the airport operator – not the airline. Damage to luggage is covered as
Chapter 3
long as something also happened to the aircraft.
Third parties other Covers baggage handlers or other ground staff.

than passengers
Products-related For illness resulting from food provided on the plane, contaminated aviation fuel being
liabilities supplied, or repairs undertaken with substandard parts.
Employers’ liability for injury to aircrew would be covered under a standard employers’
liability policy – there is no need for a specialist aviation version.
C3 Loss of licence/loss of use insurance

In the same way as we saw (for marine and non-marine insurances) in Loss of earnings
insurance on page 3/4 and Business interruption insurance on page 3/14, if an aircraft is
damaged and cannot be used, the owner could lose money. Loss of use insurance provides
a replacement income stream, after a waiting period measured in days (with a maximum
sum payable per day).
Additionally, ‘loss of licence’ insurance is available within the aviation market, which
generally deals with an individual who has failed their medical – resulting in the loss of
For reference only

licence to operate in their role as aircrew or air traffic controller. As long as the medical
failure was not their fault and they have not lost their licence because of another reason
(such as drinking on duty), this insurance provides replacement personal income.
C4 Airport operators’ policies

These policies provide insurance protection for the particular risks faced by organisations
that manage or operate airports. These policies combine both physical damage and liability
insurances and fall generally into three areas of coverage:
Premises liability Someone falling over in the duty-free shop would be reported here, although it should be
noted that if there were no negligence on the part of the insured, there would not
necessarily be a claim.
Products liability If the airport provides fuel for the aircraft.
Hangar-keepers’ If the airport provides maintenance or storage services for clients. You do not need to
liability actually have an aircraft hangar!
D Reinsurance
Reinsurance is still a contract of insurance but the entity buying the policy is itself already
an insurer and is buying the reinsurance for itself in order to transfer some of the risks it has
underwritten through risk transfer from the original or direct insureds.
In this section we will review the nature and uses of reinsurance together with the buyers
and sellers of this specific type of insurance. A more detailed review of reinsurance is
provided in study text LM2.
D1 What is reinsurance?
Insurance is a mechanism that operates to transfer risk from an insured to an insurer. Also,
insurers themselves have an insurable interest in subject-matter because of the financial
risks they have taken on by accepting insurances.
Put these two together and we have the answer: insurers who want to transfer some of their
own risk to other insurers – known as reinsurers.
It can best be summarised in the form of an equation:
Insurer paying premium to reinsurer to reinsurer accepting transfer of risk from insurer along with
=
transfer risk the premium
There are various ways to arrange this – listed at the end of this section and discussed in
detail in study text LM2.
Reinsurers can be organisations that also operate as insurers (i.e. they ‘write insurance’) or
they can be organisations that specialise in writing reinsurance (with perhaps a very small
Chapter 3
portfolio of insurance on the side).
There is no limitation on the length of the reinsurance chain; fundamentally it is a matter of
supply and demand – if someone wants to buy reinsurance and there is someone willing to
sell the product at the right price, a deal can be done.
Example 3.2
This chain is the most straightforward set of relationships showing one insurer or reinsurer
at each point in the chain.
1. A shipowner wishes to purchase insurance – they are called the original insured.
2. One insurer agrees to write the whole risk – it will be known as the insurer or original
insurer.
3. The insurer decides to purchase some reinsurance for this risk – and approaches
another insurer – it will be known as the reinsurer.
4. The reinsurer can purchase some more reinsurance for itself if it chooses from another
reinsurer.
5. That reinsurer can also buy itself some more reinsurance and this can go on forever as
For reference only

long as someone is there to sell it.
It is also possible to have more than one insurer and/or reinsurer at each point in the chain.
The London Market is a subscription market which means that more than one insurer
generally shares each risk. We will see more about this in chapter 9. Diagrammatically, the
chain would look more like Figure 3.1.
Figure 3.1: More complex chain
Reinsurer C
taking 50% of
A risk
Original insurer A
taking 50% of
the risk
Reinsurer D
taking 40% of
A risk
Shipowner
insured
Original insurer B Reinsurer C

taking 50% of taking 20% of
the risk B risk
As can be seen from Figure 3.1, Reinsurer C has sold reinsurance to insurers A and B. This
is perfectly acceptable and quite normal in the London Market; however, it is very important
for it to monitor what it has done. Although these examples and diagrams only show one set
of reinsurers, the chain of reinsurers can have many links between the original risk and the
final reinsurer in the chain who will have no information at all concerning the original risk or
risks insured.
This concept of risk and exposure monitoring is reviewed further in study text LM2.
There are many different ways of buying reinsurance, in terms of the breadth of cover. This
can be described as reinsurance covering:
• a single risk – often used for unusual risks that the insurer is writing;
• a certain class of business – for example, all business written as property, or marine
cargo;
• the insurer’s whole portfolio of business; or
• catastrophe losses.
D2 Purpose of reinsurance
Chapter 3
Reinsurance has not been made compulsory (certainly in the UK), although the purchase of
appropriate reinsurance is viewed by the regulators as good business practice.
Therefore, the purchase of reinsurance remains a strictly business decision for an insurer.
Clearly, when considering the premium for an original risk, the insurer must factor in the cost
of any reinsurance it is going to require. There is little or no point giving away the entire
inwards premium on a risk to reinsurers.
Let’s return to the equation that we looked at in Pooling of risk on page 1/16:
Premium ≥ claims + operating costs
This could be written as:
Inwards premium ≥ claims + reinsurance costs + operating costs
Remember that this equation is saying that premium has to be greater than or equal to
claims plus reinsurance costs plus operating costs.
The purchase of reinsurance does not remove the insurer’s obligation to pay valid claims
under the original insurance policy. Therefore, should the reinsurer used become insolvent,
For reference only

this is a business risk that the insurer itself faces and should not impact on the original
insured.
D3 Benefits of purchasing reinsurance

D3A Increasing capacity
Individual underwriters will have authority limits which will restrict the share of any one risk
that they can accept. The underwriter is the person (or group of people) employed by the
insurer to review and accept risks on behalf of the insurer.
By purchasing reinsurance, the underwriter can increase the individual share of any one risk
that they can accept as a direct insurer which will have the knock-on effect of helping
increase their status and market share overall.
From an organisational perspective, insurers will have a combined financial capacity that
they can accept during the course of the year, which will be monitored by the regulators.
Financial capacity
If a glass can only take a pint of water, then you can never squeeze more than a pint into
that glass, you need a bigger glass. Financial capacity is also a function of size but based
on the permission obtained from regulators as to how much business can be squeezed
into the insurer, based on premium income. If you want to squeeze more than a pint of
business into the insurer, you have to ask the regulator for a bigger glass (better known as
more capacity).
Just as we saw for individual underwriters, prudent purchasing of reinsurance will allow the
insurer to accept more direct risks, having reduced its (direct) gross exposure through
reinsurance.
This also has an obvious benefit to the customers and the intermediaries as it allows
insurers to take a greater share of risks in the first instance thus making the placing and
potentially, the claims process far quicker, without impacting the insurer's net financial
position.
Gross and net

Referring to our example of the pint glass above, the gross capacity of an insurer is the
amount of business that is written (or water poured into the glass). By buying reinsurance,
you are taking some water out of the main glass and putting it into another glass, thus
making more room to pour water into the main glass.
The net position is the one after you have emptied some water out of the main glass to
make room for more to be poured in.
Chapter 3
D3B Smoothing peaks and troughs
Insurers are keen to ensure that their trading results each year show gradual trends, rather
than high peaks or deep troughs. Importantly, investors prefer to see stability in insurance
companies.
Reinsurance helps by spreading the cost of very large losses over a period of time. In the
case of a large loss that affects an insurer and its reinsurer (where there is an arrangement
covering more than one risk), the temptation for the reinsurer might be to increase its prices
for that insurer immediately – to try to recoup its costs attached to the large loss. Doing so
would immediately affect the cost base of the insurer; instead the reinsurer usually takes a
longer-term view and applies price increases where adverse loss trends emerge. This
spreads the cost to the insurer over several years having the effect of smoothing out the
highs and lows.
When purchasing reinsurance, the insurer should consider the likely peaks and troughs in
the coming year and balance that against the amount of money it is prepared to spend on
reinsurance. It is all too easy to get the calculation wrong and have inadequate reinsurance
in any one year.
For reference only

Allowing the insurer to diversify If a new insurer is setting up or an established one moving into a new
into new classes of business class of business then the regulators (in the UK, the PRA) see the
purchase of reinsurance to protect the fledgling business as a sign of
good business practice.
Protecting the portfolio (class of It is possible to arrange reinsurance on a single known risk. When
business) insurers do this, it is known as facultative reinsurance. However, it is
equally important for insurers to protect the pool of accumulated premium
funds from the effects of very large losses or a series of losses arising
from a single cause. Therefore, it is possible to purchase reinsurance that
will cover a group of losses arising from one cause, albeit that they might
present claims through different original risks written by the insurer. This
is generally known as treaty reinsurance.
Question 3.6
Which of the following is not a reason for purchasing reinsurance?
a. The original insurer is not permitted to write the business. □
b. Risk transfer. □
c. To even out peaks and troughs in an account. □
d. To increase capacity. □
D4 Benefits of writing/selling reinsurance

Accessing other Insurers are often limited in the geographical areas from which they can source
geographical areas business – we will examine this topic further in chapter 7. Often the restrictions are
placed on insurers writing direct business, so by writing reinsurance it is possible to
widen the geographical scope of the business.
Accessing other classes Writing reinsurance is a good way of ‘testing the water’ in relation to new classes of
of business business with a limited exposure in terms of capital expenditure. Other ways of
accessing new classes of business would be to employ a team of underwriters with
Chapter 3
all the attendant issues of subsequently ‘un-employing’ them again should the
exercise not prove profitable. Generally, reinsurance is an annual contract which
does not have to be renewed and therefore if a particular contract proves to be
unprofitable then it does not get renewed.
Activity
Have a look at the Munich Re website and try to find out whether they write any direct
insurance.
www.munichre.com
D5 Sellers of reinsurance
Reinsurers are often limited liability companies with substantial amounts of paid-up capital,
sometimes in excess of £100m, due to the high risk attached to the business.
Paid-up capital is the amount of money received into the company from the shareholders –
so a company with a large amount of paid-up capital will generally have a large number of
shareholders. Companies can increase their paid-up capital by issuing more shares.
For reference only

However, some reinsurers have far less capital, meeting only the minimum statutory
requirements. Many smaller reinsurance companies operate in specialist classes of
business. The main types of reinsurer are:
• specialist companies that do not write any direct insurance at all;
• Lloyd’s syndicates; and
• insurers who also write reinsurance as well as direct business.
Reinsurers accept risks either directly from the insurer (also known as the reinsured) or
through a reinsurance broker. They provide reinsurance for:
• insurance companies;
• captive insurers; and
• other reinsurers.
Reinsurers are included in this list, as they too seek to transfer some of their risks to other
reinsurers. As already discussed earlier in the chapter, the buying of reinsurance is very
much based on supply and demand.
Reinsurance is an international business and insurers usually spread their risks over a
number of reinsurance companies at home and abroad. Many Lloyd’s syndicates also buy
and sell reinsurance to companies who are members of the International Underwriting
Association (see chapter 6).
The main reinsurance markets – other than London – are Bermuda, the US and Europe. The
Bermudan market is a major competitor to London. Many insurers who have offices in
London are in fact headquartered in Bermuda for regulatory and taxation reasons.
Activity
Review the Lloyd’s Annual Report which can be downloaded from bit.ly/2zXJMk7 and
compare the amounts of reinsurance business and direct business coming into Lloyd’s as
shown in the opening pages of the report.
Also compare with the London company market via the IUA statistics reports:
bit.ly/2x17nR6
D6 Buyers of reinsurance
Some of the main buyers of reinsurance are insurers and reinsurers; however, there are
some additional categories of buyer, namely captive insurers and mutuals.
Captive insurers A captive insurance company is one set up as part of a larger commercial
organisation and it takes risks only from its parent company or group. The
main advantage of a captive is that the parent company or group is not
impacted by general premium increases across the market. The main
disadvantage is that in the event of a loss the only source of funds
available to deal with claims are those within the captive. Obviously, the
Chapter 3
parent company should fund the captive properly and ring-fence funds to
deal with claims, but another way of protecting the captive's financial
position is to purchase reinsurance in exactly the same way as any other
commercial insurer would.
Mutuals Mutuals involve like-minded organisations grouping together and forming

an insurance pool amongst themselves, often run by professional
managers on behalf of the member firms which vary between lawyers,
architects and marine liability insurers. Mutuals purchase reinsurance
using exactly the same sort of considerations (in terms of extent and
type) as a commercial insurer.
Activity
1. Research the BP captive 'Jupiter' and see if you can find out whether it purchases
reinsurance.
2. Review the website of marine liability insurers 'International Group' and examine the
reinsurance that it purchases:
www.igpandi.org/reinsurance
For reference only

D7 Reinsurance terminology
In this section, we are going to cover some reinsurance-specific terminology. The different
types of reinsurance are covered in detail in study text LM2.
Bordereau(x) Formatted spreadsheet on which risk and claim information can be presented
to reinsurers, typically used for treaty reinsurance.
To cede The act of sharing the risk with reinsurers.
Cedant Another word for the original insurer who is passing the risk to reinsurers.
Cession The share of the risk passed to reinsurers.
Collecting note The document used to present the claim to reinsurers under an excess of loss
contract.
Facultative reinsurance Reinsurance purchased for an individual risk, generally because it would not fit
within any other part of the reinsurance already available. Will only respond to
claims arising out of that one risk.
Non-proportional reinsurance Reinsurance where the premium and claims do not have a direct correlation.
The premium will be set more in line with a direct insurance, and the claims will
be dealt with on a purely financial basis, rather than on a shared basis. Excess
of loss and stop loss are examples of this type.
Claims will be paid out in excess of a pre-agreed amount and the coverage
works in layers stacked on top of each other. This is known as vertical
protection and the cedant should consider how high they would like the layers
to go in order to give them the protection that they want. This might not be as
high as the largest loss they have ever had, as it is entirely a case of what the
cedant is prepared to pay for, and reinsurers prepared to sell them.
For example, an insurer buys reinsurance excess of US$1m, with a limit of US
$5m. The excess is the bottom layer of the pile and the US$5m limit sits
above it.
If the insurer has a claim of US$1.5m from the ground up, then they retain the
first US$1m and can claim US$500,000 from their reinsurers.
If the insurer has a claim of US$7m, then they retain the first US$1m and the
last US$1m (because the claim will pop out of the top of the layers), but they
can claim US$5m from their reinsurers in the middle.
Proportional reinsurance Reinsurance where the premium and claims are shared between insurer and
reinsurer in pre-agreed proportions, such as 30%. In the simplest form of
contract there will be no financial limitations, the reference will only be made to
proportions but in more complex contracts there will be limits expressed in
financial terms relating to the size of the risks that can be shared with the
reinsurers. Quota share and surplus treaty reinsurance are examples of
this type.
For example, an insurer might purchase a 30% quota share reinsurance. For
all ceded risks, 30% of the premium will be paid to reinsurers, and in return
they will reimburse 30% of the claims that the insurer has on those ceded risks.
Chapter 3
So, an insurer writing a risk with a premium of US$1,000 will cede US$300 to
the reinsurer (ignoring any commissions). If there is a claim for US$500,000
then the reinsurer will reimburse US$150,000 being 30% of the claim.
Reinstatement In non-proportional reinsurance (such as excess of loss) it is possible for the

cedant to "bring the layer back to life" or reinstate it, often by the payment of
additional premium.
This is known as horizontal protection, whereby the cedant has protection if
they have more than one large loss within a single year. The other advantage
to the cedant is that they do not have to pay for these reinstatements, until they
actually need them.
Some contracts can provide for unlimited reinstatements, but most have a set
number, for example three. This means that the layer has its original life, plus
three more.
For example, if a layer is £100,000, with three reinstatements, the total payable
on an aggregate basis on the contract is £400,000. The cedant might erode
that as four large losses each of £100,000, or a larger number of smaller losses
none of which use the whole layer.
Reinstatement premium The price that the cedant has to pay to reinstate or bring the layer back to life. It
might be free, but is usually a stated percentage of the original premium for
For reference only

that layer.
Retrocedant A reinsurer obtaining reinsurance for itself.
Retrocession A cession where the entity ceding is already a reinsurer.
Retrocessionaire A reinsurer accepting reinsurance from an entity that is itself a reinsurer.
Treaty reinsurance Reinsurance that can be purchased to cover a wider portfolio of risks, either a
class of business or even an insurer’s whole book of business.
Question 3.7
What is the term used for transferring a risk to a reinsurer?
a. Cede. □
b. Transfer. □
c. Claim. □
d. Payment. □
Key points
General
• Physical damage insurance can be called first party insurance.

• Liability insurance can be called third party insurance.
• Short-tail classes of insurance have a short time lag between the policy period and the
Chapter 3
final claims being concluded.
• Long-tail classes have a longer time lag between the policy period and the final claims
being concluded.
Marine
• Insures vessels, cargoes and liabilities as well as offshore energy risks.

• Also insures construction risks.
• Some risks cross over between marine and non-marine areas such as fine art and
specie.
Non-marine
• Covers buildings and liabilities associated with property.

• Also covers construction of all types of buildings.
• Liabilities also covered here including professional liabilities – all compulsory
insurances are within non-marine area.
• Onshore energy including power generation and alternative energy risks.
For reference only

• Personal accident policies are benefit policies not policies of indemnity.
Aviation
• Covers physical damage to aircraft as well as liabilities.

• Airport operators take out separate policies.
Reinsurance
• Reinsurance is the same as insurance – but the buyer is already itself an insurer.
• Reinsurance is sold by dedicated reinsurers, Lloyd’s syndicates and insurance
companies that deal in both insurance and reinsurance.
• Reinsurance is purchased by insurers, reinsurers, mutuals and captives.
• Reinsurance has several benefits for buyers such as access to new markets,
increasing capacity, assistance with starting up new business lines.
• Reinsurance has benefits for the sellers as well, such as access to new geographical
areas and classes of business.
• Reinsurance has some specific terminology which should be used to avoid confusion.
Question answers
3.1 b. Their loss of earnings policy.
3.2 c. Stock throughput insurance.
3.3 a. Liability.
3.4 d. Contingent business interruption.
3.5 c. Prize indemnity.

Chapter 3
3.6 a. The original insurer is not permitted to write the business.
3.7 a. Cede.
For reference only

Self-test questions
1. What type of insurance covers the construction of ships?
a. Builders risk. □
b. Hull and machinery. □
c. P&I. □
Chapter 3
d. Stock throughput. □
2. If you own a gallery and want to insure paintings and sculptures, which type of
insurance do you need?
a. Jewellers' block. □
b. Fine art. □
c. Stock throughput. □
d. Cargo. □
3. Which of these precautions do 'cash in transit' insurers not expect their insured to
take?
a. Varying the routes. □
□
For reference only

b. Mixing up the teams being used.
c. Not leaving the vehicle unattended. □

d. Only driving in daylight. □
4. What type of risks does political risk insurance cover?
a. Government ordering a lockdown. □
b. Assets being seized by authorities. □
c. Unpopular governments being elected. □
d. Economic recession. □
5. If a business wants to insure against employees stealing money from it, which type of
insurance is suitable?
a. Fidelity guarantee. □
b. Employers' liability. □
c. Theft insurance. □
d. Business interruption. □
6. What does a typical business interruption policy cover?

a. Loss of income due to a new competitor in your industry. □
b. Loss of income because what you are selling is not fashionable any more. □
c. Loss of income following physical damage to a factory. □
d. Loss of income following employee theft. □
Chapter 3
7. Which type of insurance would it be sensible for businesses as diverse as shops and
nightclubs to buy?
a. Political risk. □
b. War. □
c. Professional indemnity. □
d. Public liability. □
8. How is personal accident different from other types of insurance?
a. It can only be purchased by consumers. □
b. It is a benefit policy, not an indemnity policy. □
c. It has very small policy limits. □
□
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d. It cannot be sold by Lloyd's insurers.
9. Which of these is not a standard aviation-related liability?

a. Professional negligence. □
b. Products. □
c. Passengers. □
d. Third parties other than passengers. □
10. If an insurer is buying "whole account" reinsurance, what are they protecting?
a. Single individual risks. □
b. Certain classes of insurance. □
c. All the risks written by the insurer. □
d. Only against catastrophe losses. □
The insurance cycle
4
outcomes
Introduction
A Supply and demand 4.1
Chapter 4
B Supply and demand in the insurance marketplace 4.1
C Reasons why the insurance cycle might vary 4.1
Key points
Question answers
Self-test questions
Learning objectives
For reference only

• explain supply and demand; and
• outline and explain the insurance cycle.
Introduction
In this chapter, we will start by examining the concepts of supply and demand and their
application to the insurance marketplace, followed by a review of the insurance cycle.
Key terms
Equilibrium Impact of major Insurance cycle Legal and political

events influences
Necessities versus Pricing Price elasticity of Subscription market
luxuries demand
Supply and demand
Chapter 4
A Supply and demand

In this section, we will explore the concept of supply and demand and how it works in any
type of marketplace. This provides a good introduction to the specific effects that the
principles of supply and demand have on the insurance market both in London and
overseas.
A1 What is meant by supply and demand?

The principle of supply and demand is relevant for any seller or supplier; it is the relationship
between the price of the commodity and the quantity traded.
To a certain extent, it also relies on a mixture of luck, a review of historical information and –
For reference only

in some cases – the weather.
The ideal balance is that the quantity supplied equals the quantity demanded; known as
equilibrium.
Example 4.1
A shopkeeper has 500 ice creams available on a particular day for £1 each and they sell
the last one at the end of the day as they are closing the shop. Here, the supply of ice
creams exactly matches the demand. Neither side of the equation is unbalanced in any
way and everyone is happy. The shopkeeper is happy because they have sold all their ice
cream and the buyers are happy because everyone who wants an ice cream gets one, at
a price they are prepared to pay.
Activity
Imagine it is the hottest day of the year and you have just gone into a shop for some ice
cream. How would you feel if they had sold out?
Write some notes about your attitude to the shop and whether it would impact on your
decision to shop there again.
Now put yourself in the position of the shopkeeper in that situation.
Write some notes about how you, as the shopkeeper, would feel if you did not have
enough stock of ice cream to satisfy all your customers on the hottest day of the year.
What if you, as the shopkeeper, had stocked up in advance with lots of ice creams for the
school holidays and in fact, it rained for the whole summer. You have hardly sold any ice
creams, you are running out of freezer space and the expiry date on the ice creams is
approaching.
Imagine how you, as the shopkeeper, would feel in this scenario. What problems are you
facing?
Chapter 4 The insurance cycle 4/3
Staying with food products, let us consider how a shop might manage the challenges of
supply and demand. What tools can it use to ensure that it balances the equation and over
what aspects do they have little or no control?
A2 Tools to manage supply and demand

These include historic and current information, competitive pricing and exclusivity of the
product.
Historic information Past trading patterns, for example, weather reports which give a clue to
the weather patterns throughout the year, or previous patterns of demand
for a particular product.
Current information For example sporting fixtures. By knowing when major sporting fixtures
are held, shops can ensure that they have adequate stocks of barbeque
items and other essentials.
Competitive pricing The extent to which this tool can be used is entirely dependent on the
size of the organisation and the extent to which it can balance out
Chapter 4
aggressive pricing in one area with realistic pricing in another (so as not
to end up putting itself out of business).
Exclusivity of product If a shop is the only supplier in the area, this provides an element of
control; as shoppers will generally only travel a certain distance to buy
basic products.
People are prepared to make a special long-distance trip to places such as an exclusive
department store which only exists in London, but will not be prepared to make a long
journey to obtain a pint of milk that they can get nearer home. The difference between these
suppliers is as follows:
• The London store is a high order service and has a large sphere of influence; people
For reference only

will travel a long way for that one-off special purchase.
• The local milk supplier is a low order service and has a low sphere of influence. People
will not travel far to purchase a pint of milk.
Reinforce
If we apply these concepts to communities we can see a similar model appearing:
Village – serves the local community only.
Town – serves a wider area including a number of villages.
City – serves a much bigger area including a number of towns and villages.
Activity
Think about the following products:
• a loaf of bread;
• weekly food shop; and
• new sofa.
How far away from where you are typically based would you be prepared to travel to
obtain this product? (Ignore for this exercise the impact of online shopping.)
A3 Over what do shops have little or no control?

Shops have little or no control over:
Competition in the local area this can be partially controlled by the competitive pricing mentioned above but
cannot be completely overcome.
Data used for forecasting or particularly data such as weather forecasting or changes in fashion.
decision-making being
inaccurate
A4 Pricing impact on supply and demand

Can shops charge whatever price they want for products? What is the effect on demand to a
change in price? If the price of an ice cream was to double overnight, it is expected that
demand will fall, as people will go without an ice cream or buy a cold drink/ice lolly instead.
Compare this to an increase in the price of petrol. If the price of petrol goes up by 25%, what
effect will this have on demand? Compare this also to a commodity such as car insurance. If
at renewal, the premium quoted has gone up 25% on last year, what effect does it have on
your decision to purchase?
Consider this…
If your favourite bar of chocolate cost £1 yesterday and today it costs £2, but most other
chocolate bars are £1, would you still buy your favourite one, if there was no other obvious
difference?
Chapter 4
A4A Necessities versus luxuries

Products can be divided broadly into necessities and luxuries which has an impact on their
demand and whether they are purchased at all. Insurance would not generally be called a
luxury as there are many situations where the buying of insurance is either obligatory or
required as a term of doing business (i.e. as a prerequisite for obtaining a loan to purchase a
building or a ship).
Reinforce
Can you remember which types of insurance are compulsory in the UK?
If an item is a necessity, then a change in price will potentially have less impact on demand
For reference only

than if the item is a luxury. However, there is a basic relationship between price and demand
that we will review briefly.
A4B Price elasticity of demand
Put simply, if the price of a product or service goes up the demand for it goes down. The
‘elasticity’ element is working out how much the demand goes down as the price goes up.
Reinforce
If the price of an ice cream goes up 10%, what will be the effect on demand?
Knowing the degree of elasticity is important; if you know that the demand for ice cream
will drop by more than 10% if you raise the price by 10%, then it is not worth the risk of
raising the price. Conversely, if you know that demand will drop by only 3% if you raise the
price by 10%, then it tells you that the market can bear the price rise and good business
tells you to do it.
Activity
Speak to six of your colleagues, friends or family who have car insurance. For each
of them:
1. Find out what type of insurance they have, comprehensive, third party, fire and theft or
third-party only. (Remember that only third party insurance is compulsory, anything else
is a choice.)
2. If they have comprehensive cover, ask them: If the price had been too high for
comprehensive, would they have bought a lesser insurance or would they always pay
for comprehensive, whatever the price?
A5 Achieving equilibrium
If demand is present for a certain product, there are three types of status that can be used to
describe the marketplace:
• Equilibrium: there is just enough supply to meet demand.
• Under-supply: there is not enough supply to meet demand.
• Over-supply: there is more than enough supply to meet demand.
B Supply and demand in the insurance

marketplace
In this section, we will apply the concepts learned so far in this chapter specifically to an
insurance market.
B1 Why new insurers join the market
Chapter 4
New insurers join the insurance marketplace if they think that there is greater demand than
there is current supply; i.e. that the insurance marketplace is not in equilibrium and there is
under-supply. The new insurers think they can make a profit by increasing supply.
Example 4.2
Imagine a marketplace with one trader selling ice creams. They are the sole provider in
the area and have many customers. Queues often form and by mid-afternoon, they have
sold out. Other business people see their success and set up market stalls in the same
area selling the same ice cream at the same price. Some of the original trader’s
customers go to the new traders although there is no obvious price-cutting taking place.
For reference only

The key to this part of the pattern or cycle is that ‘new players’ are coming into the market
with the expectation of making a profit as they can see that the player currently in the market
is already doing so.
Subscription market
The London Market has many insurers working within it and a number of them can take
shares of the same risk depending on their appetite and capacity. This type of market is
known as a subscription market.
By entering the market, the increased investment or capacity in that area of the market
increases the supply of goods (whether ice creams or insurance coverage) and this has an
impact on price.
In a subscription marketplace, there is no price control; the insurance brokers are of course
trying to obtain the best product for their customers (a balance between price and terms and
conditions). If insurers start to compete for business and try to maintain their market share
(because there is more supply than there is demand) then one of the easiest areas in which
to compete is price.
If aggressive pricing takes place (where insurers are prepared to accept business at a price
that is very low in relation to the perceived risk being presented) then pressure is placed on
the rest of the market to accept risks at a lower price to obtain or maintain a share of
business.
Example 4.3
Let us look at the next stage of the story of the marketplace for ice cream traders:
• More market traders come in and are all selling the same vanilla ice cream in the
marketplace.
• The demand is then split equally between them. However, at the end of the day, one of
them has ice cream left over so reduces their price to get rid of it.
• As the other market traders see what they are doing, a couple of them start to get
aggressive in their pricing to try to get a larger share of the demand. This means that
unless the others can come up with other ways to attract customers, they too will have
to reduce their prices to remain competitive.
• Then due to completely unforeseeable circumstances, the vanilla crop fails and supply
stops overnight. The commodity price goes up ten-fold and there is an insufficient
supply of vanilla to meet the demands of ice cream manufacturers.
• Total ice cream supply is reduced, whilst demand remains unchanged. This shortage of
Chapter 4
supply forces prices up. At the same time due to higher than anticipated production
costs, manufacturers and sellers leave the market because they believe that they will
not be able to sell at the price required to cover their new increased production/
purchase costs. The ice cream market is in turmoil and totally out of equilibrium.
Question 4.1
If a particular class of business is profitable, more insurers will decide to write that
class of business. What impact, if any, is this most likely to have on rates?
a. No impact. □
□
For reference only

b. Rates will decrease.
c. Rates will increase. □

d. No pattern will emerge. □
B2 Why insurers leave the market
The main reason that insurers leave the market is that they suffer large losses, which leads
to lower profits (or no profits at all). While the losses will not be caused entirely by lowering
their premiums too far, the lack of premium income generated will, of course, make any
losses more painful in the long run. Certain classes of business are more volatile than
others, in that losses – when they are suffered – tend to be large. A good example of this
would be the offshore energy insurance market. After the 2005 hurricanes hit the Gulf of
Mexico, a significant number of insurers (both in London and elsewhere in the world) swiftly
exited the offshore energy insurance market – and many others chose to restrict heavily the
coverage they provided.
However, in 2018 a number of Lloyd’s syndicates either left the market completely or
significantly changed their business plans. This was because Lloyd’s (as a partial regulator)
was not prepared to give them permission to write the business they wanted to in 2019.
Therefore, this was not necessarily a voluntary exit but an enforced one.
Activity
If you work for a Lloyd’s syndicate, speak to colleagues and find out if your organisation
was impacted by this action taken by Lloyd’s.
If you work for a broker, find out whether any insurers that you historically used are no
longer available.
If you work for a coverholder/managing general agent, find out whether your capacity has
changed this year because of insurers leaving or joining the market.
If you work for a service provider or any other organisation, consider how this might
impact your organisation. Do you have to find new customers?
Example 4.4
Let us continue the story of the ice cream market traders. Remember that prices were
forced low when the other traders came in, then the price of vanilla became high thus
impacting on the price at which the traders will be buying in the stocks of ice cream. Some
of the traders cannot afford to remain in the market as they have to sell ice creams at a
price lower than they obtain them from their suppliers – thus making a loss.
Activity
Speak to colleagues involved in business planning. Has anything that has happened in
the last year or two (whether it be storms or anything else) changed your organisation's
business model for 2023/24 and beyond?
B3 Impact on rates of new market entrants and leavers
Chapter 4
In the shopkeeper examples in What is meant by supply and demand? on page 4/2, we saw
that an over-supply has the potential impact of pushing down prices. When an over-supply is
rebalanced, it is possible that it will swing too far the other way and the supply becomes too
low to satisfy demand. This means that the sellers can control the price more readily and
prices will go up.
The increase in price will lead generally to profits and those outside the market will think it is
now a good time to join (either again or for the first time).
Figure 4.1 presents this cycle in relation to insurance:
Figure 4.1: New entrants to the insurance market: impact on rates
For reference only

Prices are high and higher
profits (or any profits at New insurers come into
all) can be made the market increasing
capacity
Losses are made or just Prices are forced down

lower profits and as there is more supply
insurers leave the than demand and
market thus reducing aggressive pricing can
capacity take place
Question 4.2
After a major hurricane many insurers decide to stop writing windstorm business.
What is the likely impact on rates, if any, of this decision?
a. No change to rates. □
b. Rates will decrease. □
c. Rates will increase. □
d. Rates will stabilise. □
It is quite common to hear the words hard and soft applied to the market at any point in time
or even to different sectors of the market. A hard market is one where there is an excess of
demand over supply and one where insurers have more ability to influence rates due to less
capacity. Conversely, a soft market is one where there is an excess of supply over demand
and it is far more difficult for insurers to push prices up.
Activity
Speak to colleagues and see whether insurance rates are rising in any class of business
that they might be involved in or whether they are remaining flat or even falling.
C Reasons why the insurance cycle might

vary
In this section, we will look briefly at the sort of external influences that might impact on the
insurance cycle, causing it to go round either more quickly or slowly than expected – or
perhaps not operate at all as expected.
Chapter 4
C1 Legal and political influences

• The law might be changed to make more or fewer types of insurance compulsory.
Consider this…
If the law was changed to make comprehensive motor insurance compulsory, do you think
that lots of insurers, not currently writing motor insurance, would join the market? What
impact do you think that would have on prices if they are aggressive in their pricing to get
market share quickly?
• The law might change to extend liabilities for which insureds can be found responsible –
For reference only

even during the currency of a policy. These liabilities may not have even been
contemplated when the risk was written. The international nature of the market means
that it is not just changes in English law that impacts on insurers’ exposure as the
insureds that are covered by London Market insurers are based and work worldwide.
• The ability of the market to write business in certain parts of the world might be
increased. For example, the work done to extend the ability of Lloyd’s syndicates to write
business coming out of India by obtaining a licence from the Indian authorities or by
opening offices in Latin America.
Activity
Read about Lloyd's in Brazil: www.lloyds.com/en-br/lloyds-around-the-world/home
As a result of the Brexit vote, Lloyd’s in conjunction with other insurance organisations
decided to establish a platform within the EU setting up an insurance company in Brussels.
Lloyd’s Brussels opened for business in late 2018 and has accepted risks incepting since 1
January 2019.
On the Web
Read more about Lloyd’s establishing an EU platform in Brussels here:
www.lloyds.com/about-lloyds/media-centre/press-releases/lloyds-brussels-starts-new-
chapter-for-lloyds-in-europe
Activity
Find out what impact Brexit has had on your organisation – have you opened new offices
perhaps?
C2 Impact of major events

The World Trade Center loss in 2001, as well as the 2005 and 2017 hurricanes in the Gulf of
Mexico, were some of the largest losses to hit the London insurance market. The capacity of
Lloyd’s to write business has not decreased year on year, although some market participants
have chosen to leave certain sectors (such as the offshore energy market post-2005 or
recently, the aviation war market as previously stated).
The general impact of these events is to shorten the insurance cycle as they accelerate the
reduction in individual players (i.e. supply is less) in certain areas of the market, thus
permitting significant increases in premiums.
Weather-related events have an impact on insurers. As well as the hurricanes just
mentioned, these include events such as large-scale flooding, as seen in recent years both
in the UK and in Europe. Such events call into question historic data on which insurers base
their planning – such as the likelihood of catastrophic weather more than once in 100 years.
The uncertainty that this produces can drive insurers away from certain classes of business
Chapter 4
in a way that will also impact the cycle.
In 2020 the international insurance market faced one of the largest and most disruptive
events in its history with the COVID-19 pandemic. This situation presented significant
insurance losses in many different classes, particularly contingency due to cancellation of
major events such as the Olympics and the Euro 2020 football tournament. A number of
insurers have already decided not to carry on in that class.
However, this situation also forced businesses to completely revise their ways of working.
The decision to close office environments completely and move to remote working in
response to government lockdown requirements was taken relatively quickly by most
organisations. It rapidly identified those companies who were in a better position to carry on
working in this environment, for example because they already had enough licences for
For reference only

remote access to systems or in fact had already embraced remote working as part of the
normal working cycle.
The London Market had been using electronic placing systems for some time but with no
great overall enthusiasm. The COVID-19 situation forced both brokers and insurers to rapidly
engage with and come to terms with the technology if they wanted to carry on operating at
all. One system (PPL) reported an increase in users immediately after lockdown in mid-
March 2020 of 40% and Insurance Day reported on 2 July 2020 that over the July renewal
period 12,000 lines were bound using that system. There are other systems available to use
such as Whitespace and these have also seen a significant increase in users since the start
of the first lockdown.
On the Web
Those insurers who had alternative platforms such as online underwriting portals were in a
good position to benefit from the new way of working. Read this article to see how one
London Market insurer's portal broke records in May 2020:
aegislondon.co.uk/about-us/press-releases/2020/aegis-london-tom-squires-digital-
trading.html
Activity
If you work for an insurer, speak to colleagues to find out more about how you are using
digital platforms such as PPL, or Whitespace or whether you have your own online
portals. Have you decided to close down any particular classes of business following
COVID-19 losses.
If you work for a broker speak to colleagues to find out their views about electronic placing
and also whether they have found that any markets are pulling out of their particular
classes.
Question 4.3
What is the most likely impact on the market if a catastrophic loss is suffered?
a. Lower capacity and higher premiums. □
b. Lower capacity and stable premiums. □
c. Higher capacity and stable premiums. □
d. Higher capacity and lower premiums. □
Chapter 4
For reference only

Key points
Supply and demand
• The relationship between supply and demand is a balance that applies equally to
insurance as to any other product.
• Balance can be impacted by the necessity or otherwise to buy insurance.
• Price has an impact on demand but an increase in price may not produce an equal
change in the demand.
Supply and demand in the insurance marketplace
• The insurance market grows and shrinks in a cycle based on insurers seeing profits
being made and wanting to join the market and share in those profits.
Chapter 4
• Aggressive price reductions will lead to losses and insurers will leave the market again,
thus allowing those remaining to generally increase the price again.
Reasons why the insurance cycle might vary
• Large losses due to weather and natural catastrophes can shorten the insurance cycle.
• Changes in the law and major events have the potential to change the cycle.
For reference only

Question answers
4.1 b. Rates will decrease.
4.2 c. Rates will increase.
4.3 a. Lower capacity and higher premiums.

Chapter 4
For reference only

Self-test questions
1. Which expression best defines supply and demand?
a. Supply is the provision of something and demand is need at any price. □
b. Supply is provision of something as cheaply as possible and demand is need at □
that price.
c. Supply is the provision of something and demand is the need for something but □
only at a certain price.
d. Supply is the provision of something at any price and demand is need at the □
cheapest price.
2. Which of these is not a tool that can be used to manage supply and demand?
a. Historic information. □
Chapter 4
b. Competitive pricing. □
c. Exclusiveness. □
d. Using only online advertising. □
3. Which type of insurance would be described as a necessity in the UK?
a. Pet. □
b. Motor. □
For reference only

c. Home contents. □
d. War. □
4. If the market is said to be in equilibrium what is the relationship between supply and
demand?
a. Just enough supply to meet demand. □
b. A little more supply than demand. □
c. A little more demand than supply. □
d. No link between supply and demand. □
5. If there is more demand for insurance than insurers in the market what will be the
likely result?
a. More insurers will leave the market. □
b. Rates will increase. □
c. Rates will decrease. □
d. Regulators will intervene. □
6. After a major loss what is likely to happen to the supply of insurance?

a. Supply will increase as new insurers join the market. □
b. Supply will stay the same. □
c. Supply will reduce as insurers leave the market. □
d. Regulators will seek to control insurers' movement in the market. □
7. How might a change in the law making more classes of insurance compulsory impact
on supply and demand?
a. Greater demand will be created. □
b. Demand will stay the same. □
Chapter 4
c. Demand will reduce. □

d. Greater demand will be created at the start but will then reduce. □
For reference only

Structure of the
5
London Market
outcomes
Introduction
A Lloyd’s Market 6.1
B Company market 6.1
C Brokers 6.1
Chapter 5
D Managing general agents 6.1
E International aspects of the London Market 6.1, 6.2
F Market associations 6.3
G Flow of business in the London Market 6.2, 6.4
For reference only

Key points
Question answers
Self-test questions
Learning objectives
• describe the main participants in the London Market and the implications of their
participation;
• explain the role of the London Market Associations;
• explain the importance of the London Market; and
• explain the process flow in the London Market.
Introduction
The London Market is a distinct, separate part of the UK insurance and reinsurance sector.
The main providers in this market are:
• insurance and reinsurance companies;
• Lloyd’s syndicates (who will also operate outside London through service companies);
and
• Protection and Indemnity Clubs (dealing with aspects of marine liability insurance).
Much of the business is conducted internationally, including significant insurance and
reinsurance arrangements.
The London Market is the place where many sizeable or complex industrial risks from all
over the world are placed. This market, and perhaps the Lloyd’s Market in particular, has
been a focus for placing very unusual risks and is arguably unique in the world in this
respect.
To give an indication of its size, the gross written premium of the Lloyd’s market in 2021 was
£39.2bn (source: Lloyd’s Annual Report 2021).
Key terms
Chapter 5
Brokers Captive insurers Contract certainty Council of Lloyd’s

Limited liability Lloyd’s of London Lloyd’s Franchise Managing agent
company Board
Managing general Members’ agent Mutual companies Mutual indemnity
For reference only

agent (MGA) associations
Names Open years Placing a risk Presenting a claim
management
Reinsurance to Society of Members Syndicates
Close (RITC)
A Lloyd’s Market
A1 Market structure and features
The first and most important thing to appreciate is that Lloyd’s is not an insurer. Instead it is a
marketplace. It is also a world-renowned insurance brand, without ever actually providing
any insurance itself.
On the Web
See www.lloyds.com/lloyds/investor-relations for the latest Lloyd’s Annual Report
containing a graphical representation of the sources of capital.
Lloyd’s of London is a Society of Members; and the Corporation of Lloyd’s provides the
infrastructure for the marketplace together with a responsibility for international liaison. This
will be discussed in more detail in chapter 7.
Under the Lloyd’s Act 1982, the Council of Lloyd’s was created and is responsible for the
management and supervision of the Market. Lloyd’s is a dual regulated institution, with both
the Society of Lloyd’s and Lloyd’s managing agents being regulated by both FCA and PRA,
whereas Lloyd’s brokers and members’ agents are solely regulated by the FCA. More about
these regulators will be explained in chapter 6.
The Council typically has three working, three external and nine nominated members. The
working and external members are elected by Lloyd’s members. The Chairman and Deputy
Chairmen are elected annually by the Council from among its members. All members are
approved by the FCA.
Chapter 5 Structure of the London Market 5/3
Definitions
A working member is one who is actively working in the Lloyd’s Market either for a broker
or for a managing agent, or did so immediately before retirement. These members have to
be members of the Society of Lloyd’s, i.e. provide capital for the market.
An external member is one who is a member of the Society of Lloyd’s (i.e. a provider of
capital) but does not fulfil the criteria for a working member.
A nominated member is not a member of the Society and a capital provider but comes
from outside the market. The nearest equivalent would be the non-executive directors of a
company who are not involved with the day-to-day operation of the business.
The Council can discharge some of its functions directly by making decisions and issuing
resolutions, requirements, rules and byelaws. The byelaws can be described as market laws
which organisations working within the Market such as the managing agents (see Managing
agents on page 5/4) must comply. Only the Council can make byelaws, even though it
devolves authority to other bodies and committees within Lloyd’s.
Currently, there are 38 byelaws in force but they are wide ranging and cover subjects as
diverse as underwriting and accounting.
Activity
Go to www.lloyds.com and review the operational management structure of Lloyd’s.
Chapter 5
Consider the way in which any of the elements impact on the organisation you work for.
Question 5.1
What is the name of the entity responsible for the management and supervision of
For reference only

the Lloyd's Market?
a. The Council of Lloyd's. □
b. The Risk Committee. □
c. The Corporation of Lloyd's. □
d. The Financial Conduct Authority. □
See Lloyd’s Market governance on page 6/16 for more about the Council.
A1A Syndicates
Syndicates are the groups of private individuals or corporate investors who carry the risks
(i.e. they provide the financial backing). Both types of investor (individual or corporate) are
known as underwriting members or Names.
In the 1990s there were over 400 syndicates; however, at the end of 2021, there were just
90, made up of 75 syndicates writing re/insurance, 12 set up solely to write reinsurance of
another syndicate and 3 new 'syndicates in a box' – who write innovative new business.
On the Web
Use this link to find out more about syndicates in a box: www.lloyds.com/join-lloyds-
market/underwriter/syndicate-in-a-box.
This reduction in number of syndicates does not mean that the Market has substantially
decreased in size since the 1990s; in fact, the reverse has occurred. However, the individual
organisations in the Market are now much more substantial in size than they used to be. The
size referred to is not their employee head count but their capacity to accept risks.
Syndicates have an unusual status under English law as they have no separate legal
existence and are merely a sum of their parts (the members), unlike a limited company
which exists as a separate legal entity distinct from its shareholders.
Shareholders are the investors in a company, but they are protected to a certain extent in
that the company exists in law separate from them as individuals and hence the liabilities of
the company are not necessarily transferred to the shareholders.
Reinforce
Looking at it another way – think of a sports team. They play matches each week and they
will always be known by the team name, but the individual players might vary from match
to match.
Syndicates are often described as Annual Ventures since they exist for one year only and,
therefore, should be properly identified not only by their name or number but also by the
relevant year (known as a ‘year of account’). A syndicate has a unique name and number
(known as its pseudonym) and this remains the same irrespective of the year of account. An
example of a pseudonym is HIS/33 which stands for Hiscox, Syndicate 33.
As the syndicates exist only for one year of account, the membership of the syndicate needs
to be renewed for each new year of account. As we will see later the membership of the
syndicate may stay the same year on year; however, the distinction between the individual
years of account must still be made. As the syndicate is just an amalgamation of the
members, it requires another entity to perform the day-to-day operational functions of an
insurer. This entity is called the managing agent.
Chapter 5
Question 5.2
For how long does a syndicate exist to accept risks?
a. Three years. □
b. Eighteen months. □
For reference only

c. Unlimited life. □
d. One year. □
A1B Managing agents
Each syndicate employs a managing agent and it is that entity which appoints the
underwriters who may accept risks on behalf of the syndicate. Managing agents are
companies specifically established to manage the underwriting of one or more syndicates.
Syndicates and managing agents

There were (by the end of 2021) 50 managing agents and they are often known by the
same name as the syndicate or syndicates that they manage (which can lead to
confusion). Using the example above, Hiscox, Syndicate 33 is managed by Hiscox
Syndicates Limited.
A managing agent is an authorised person, regulated by the PRA for prudential requirements
and by the FCA for conduct of business issues.
A1C Capital and members/Names
Capital is the term used for the investment put into the Market by the investors known as
members or Names. In today's Market, the vast majority of the capital is provided by
corporate Names rather than individuals, although individual members do still exist.
In order to invest in the Market, prospective members (of either type) must be able to show
adequate means in a form acceptable to Lloyd’s. In practice, this means that Lloyd’s needs
to be satisfied that the prospective member should be able to pay any claims made
against them.
Up until 1994, all members of Lloyd’s were private individuals who had unlimited liability,
which is as it sounds, personal liability with no upper limit. In the late 1980s, the Lloyd’s
Market received a number of large claims relating to natural catastrophes such as Hurricane
Hugo, some large physical losses such as the Piper Alpha rig in the North Sea and a
substantial value of claims arising from pollution, asbestos and health hazard problems
originating mainly in the USA. The sheer financial magnitude of these losses hitting the
Market meant that many members were faced with very large requests for funds from Lloyd’s
which, because the members had unlimited liability, could not be capped.
Consider this…
Having unlimited liability to someone really means that they can come and ask you for
money and keep on asking for money even when you say that you do not have any more.
It means that you will have to sell your possessions to raise more money until you have
paid your debts.
One way to avoid debts is to make yourself bankrupt but this is a legal process and will
involve handing over cheque books and credit cards to the court, and your bank accounts
will all be frozen at least at the start of the process.
Think how you would feel in this position.
To appreciate why the pollution, asbestos and health hazard problems were an issue, you
need to understand how the annual life of a syndicate works in practice.
• Each syndicate lasts for a year and will accept risks during that year and will be liable for
claims arising from those risks.
• The syndicate will, in fact, keep its books open for another 24 months after the end of the
Chapter 5
year – not only to let premium finish coming in, but also to allow claims to be notified and
hopefully resolved, relating to those risks.
• At the end of the third year, the syndicate wants to close its books and work out if it has
made a profit or a loss. But what if claims are still notified in the future, or have been
notified but have not yet been resolved?
For reference only

• A possible solution to this problem is to reinsure the outstanding liabilities – but with
which organisation? The answer to this question is usually ‘reinsure them with the
syndicate’s next year of account’. Therefore, a syndicate’s 2020 account would reinsure
its liabilities into the 2021 account.
• This is called ‘Reinsurance to Close’ (RITC) and Lloyd’s syndicates have performed this
exercise for many years.
Open years
If an agreement cannot be reached to reinsure the liabilities of any syndicate year of
account, then that year is left open until more clarity can be obtained on outstanding
liabilities. Once clarity is obtained then further attempts can be made to agree a RITC.
Open years management is covered in more detail in study text LM2: London Market
insurance principles and practices.
Example 5.1
Syndicate A writes risks between 1 January 2020 and 31 December 2020.
Syndicate A leaves its books open during 2021 and 2022 for that 2020 year of account.
In early 2023 it reviews the books relating to the 2020 year of account and calculates a
RITC premium to pay to the 2021 account so that the 2020 year accounts can be finalised
and closed – enabling either a profit or loss to be declared.
• Therefore, when claims were presented against policies written by syndicates in the
1950s and 1960s, the successor syndicates in existence in the 1980s had to deal with
them. The main problem was that as the claims (such as those relating to asbestos) had
never been anticipated, no reinsurance premium had ever been rolled forward year-on-
year to deal with the claims – leaving the modern syndicates facing huge claims that were
completely unexpected.
Recall from earlier in this section we discussed that prior to 1994 the Market investors or
Names were individual investors. Those individuals were faced with enormous claims and
with unlimited liability, many of them were bankrupted as a result.
The result of that period in the history of Lloyd’s was a need to rebuild the Market and this
was done through a process called Reconstruction and Renewal (R&R) whereby a
dedicated reinsurance vehicle called Equitas was created. The entirety of the Lloyd’s Market
for the 1992 year of account and prior was reinsured into Equitas and the ‘new’ Lloyd’s
Market started with a ‘clean sheet’ for the 1993 year of account.
Reinforce
Remember the concept of RITC where years of account were reinsured into the next year.
Some syndicates open years which could not be closed before R & R were also made the
responsibility of Equitas.
Following this R&R, corporate capital or investors were brought into the Market and the
amount of corporate capital in the Market is now high. No new individual Names with
unlimited liability are permitted to join Lloyd’s, however, if a Name was writing on an
unlimited basis prior to 1 January 2001 they can continue to do so. Individual Names with
limited liability are still welcome although, in reality, many of the old unlimited liability Names
have converted to limited liability Names.
On the Web
See www.lloyds.com/lloyds/investor-relations for the latest Lloyd’s Annual Report which
contains a graphical representation of the marketplace.
Chapter 5
By allocating their capital support to each syndicate every year, the members govern the
amount of business that each syndicate can underwrite each year: the syndicate capacity.
Some corporate members will only ever support one syndicate, primarily because they only
exist to provide capital for that syndicate. Other corporate and individual Names can decide
For reference only

whether to focus on one syndicate or to spread their investment. They are advised as to their
investment in the Market by members’ agents.
The total capacity of any given year is the aggregate capacity of the syndicates for that year.
Lloyd’s capacity has shown reasonably steady increases since 1999.
Reinforce
Can you recall the pint glass analogy from Benefits of purchasing reinsurance on page 3/
24? – refer back to it to refresh on the concept of capacity.
Question 5.3
What is the name used for the investors in the Lloyd's Market who are also
commercial organisations in their own right?
a. Unlimited Names. □
b. Corporate capital. □
c. Scottish partnerships. □
d. Individual Names. □
A1D Members’ agents

The first role that a members’ agent performs is to advise their client on the advantages and
disadvantages of investing in the Lloyd’s Market, as part of a wider investment portfolio. The
member can spread their investment across several different syndicates, not necessarily all
managed by the same managing agency. Additionally, their choice of syndicates should
reflect their attitude to risk.
It is important to realise that some syndicates do not have individual members and some
have capacity that is almost completely provided by individual members. A function of the
managing agent to decide how to run the syndicate including sourcing capacity. Good
relations between managing agents and members’ agents are very important in attracting
new investment into a syndicate.
If the client (member) is quite ‘risk averse’ then investing in a syndicate that writes motor
business might historically have given modest, but steady returns (although not today with
the sharp increase in motor claims values!). Having the opposite attitude to risk would open
up the possibility of investing in syndicates writing other classes of business which are more
volatile, such as offshore energy. Whilst this route provides prospects for large profits, it also
provides the potential for large losses.
Private members now enter the market through Limited Liability vehicles, the two main forms
of which are "Nameco"s which are UK limited companies or a Limited Liability Partnership
(LLP). In 2022 the minimum capital funding requirement for either structure is GBP 350,000.
Chapter 5
However, every member of an LLP must put up GBP 100,000. With both vehicles, the losses
are limited to the assets held within the structure which can include the value of the structure
itself if sold.
In normal circumstances, the managing agents agreement that each member enters into
with a managing agent gives them what is known as security of tenure. This means that a
For reference only

member has an automatic right to participate in the following year of account of the
syndicate. The managing agents cannot terminate their involvement without the agreement
of Lloyd's itself.
This type of capacity is a tradable asset, so a Member can trade it every year in the Lloyd's
Capacity auctions. For profitable syndicates, the opportunity to obtain the chance to
participate in that syndicate will be highly valued when it becomes available.
Alternatively, the Member might have what is known as a limited tenancy. This means that
their arrangement with the managing agent terminates after a predefined period of years, or
by the managing agent giving a pre-agreed period of notice. This type of capacity offers
members the opportunity to become involved in syndicates more easily and for the
syndicates to "refresh" their capacity more regularly.
If a syndicate wants to use limited tenancy arrangements then it must obtain the permission
of Lloyd's.
The members’ agent also acts as the communication channel between the member and the
various managing agencies running the syndicates in which the member has invested,
receiving the regular reports on the profit (or not) made by the syndicate. Every year, the
members’ agent advises the member as to any changes in the spread of investments for the
following year of account.
Be aware that the terms investment and investor in this text are used in a generic way.
Question 5.4
If a Lloyd's Name feels that they have been badly advised concerning their
participation in a particular syndicate, about whose advice will they complain?
a. The Corporation of Lloyd's. □
b. The members' agent. □
c. The managing agent. □
d. The Council of Lloyd's. □
B Company market
Any company wishing to transact insurance in the London Market must be authorised to do
so by the PRA. The term for such companies is ‘insurance undertakings’.
The regulators must be satisfied that the applicant complies with the conditions laid down in
UK legislation and European Union directives, where relevant.
A number of differences between the company market and the Lloyd’s Market will be
reviewed here.
B1 Market participants
The company market in London is very varied in terms of the origin of the companies
working within it. Many large international insurance and reinsurance organisations have
branch offices in the London Market, as well as UK based companies, such as Royal Sun
Alliance, which might also have a large UK regional presence.
B2 Marketplace
There is no equivalent in the London company market for Lloyd’s in its role as the provider of
a physical marketplace.
B3 Regulation
Chapter 5
The PRA regulates insurance companies operating in London for prudential requirements
(solvency/levels of capital etc.); the FCA regulates them for conduct of business issues. EU
companies are regulated by their own home regulator. There is no additional regulation
provided for companies in the same way that managing agents and syndicates are subject to
Lloyd’s regulation. The trade body for the company market – the International Underwriting
Association of London – has no regulatory power.
For reference only

Since the UK left the EU a number of UK companies have had to set up EU based
operations, or legally redomicile existing operations to enable them to continue to write and
service European business. This is because an EU based insurer can benefit from the
mutual recognition of regulation between EU countries, whereas a UK regulated insurer
would have to obtain individual regulatory approval in each country in which it wanted to
operate.
B4 International liaison
Lloyd’s engages in liaison with overseas regulators on behalf of the whole Lloyd’s Market but
individual companies have to make this contact with the regulators separately.
B5 Structure of the insurer

Non-Lloyd’s insurers can take a variety of formats such as limited liability companies,
mutual indemnity associations, mutual companies and captive insurers.
Limited liability companies the most common format and the one used by the household names such as
Aviva, AXA, Churchill and Zurich.
Mutual indemnity these are similar to syndicates and managing agents in that they are groups of
associations like-minded customers who pool together to create their own insurance pool and
organise professional managers to run the business. A good example of these is
the Protection and Indemnity Associations set up to handle marine liability
business.
Mutual companies these are owned by the policyholders and generally serve a specific interest
group – the most well-known example is the National Farmers Union – NFU
Mutual. All profits made are either retained within the company or returned to the
policyholder as a dividend or as reduced future premiums.
Captive insurers these are insurance companies who are solely insuring risks from sister
companies in the same group – such as Jupiter which as we saw earlier is the
captive insurer for BP.
There is a unique type of company which obtains its capacity to underwrite not from
shareholders but from a Lloyd’s syndicate. What this means, in reality, is that the Lloyd’s
syndicate has authorised a company to underwrite business on its behalf. Delegated
underwriting is discussed in more detail in study text LM2; however, this type of company,
which is generally known as a service company, is quite popular so worth mentioning albeit
briefly here.
Activity
Search for AXA XL on the internet. See if you can identify how many different types of
insurer exist within that organisation. Look for Lloyd’s syndicates and insurance
companies. Consider why any organisation would choose to have more than one
underwriting platform. What are the benefits and are they impacted by any additional
administration or regulation?
Then search for QBE and see if they have a different type of insurer within their group
based in London.
Finally, if you work for a Lloyd’s organisation, ask your colleagues whether you have any
service companies within the group.
B6 Source of capacity
For the limited liability and mutual companies, the shareholders (who are the investors in the
company) provide the capital and hence capacity for an insurance company to accept risks
and to do business.
In a pure mutual organisation, the only risks are coming from the members of the group who
Chapter 5
will be charged premium based on the size of the risk brought into the pool.
The shareholders in an insurance company may or may not take professional advice before
purchasing shares in the company; it will be entirely a matter of personal choice. However,
an individual Lloyd’s member has to use the services of a members’ agent.
For reference only

The shares in an insurance company can be publicly traded (i.e. anyone can purchase them)
or can be privately held.
Activity
If you work outside Lloyd’s make some enquiries and find out what type of organisation
you work for. If you work in a Lloyd’s insurer, find out if the managing agent is a limited
company.
The various types of companies and their structures are discussed in more detail in study
text LM2.
Question 5.5
What is the name of an insurer that only accepts risks from 'sister organisations' in
the same group?
a. Single insurer. □
b. Captive insurer. □
c. Solo insurer. □
d. Capital insurer. □
C Brokers
Refer to
The role of the broker is explored further in chapter 8.
Brokers are professional intermediaries and act as the agent of the re/insured in both the
placing and claims process. An intermediary can be defined as a middle-man and can exist
in many different areas of business, not just insurance.
They must be authorised by the regulator (FCA), but brokers can apply to Lloyd’s to obtain a
second accreditation as a Lloyd’s broker. Non-Lloyd’s brokers are not prevented from placing
business in the Lloyd’s market, however.
Consider this…
If you work for a broker – is it a Lloyd’s broker? If so, why do you think your company has
obtained that second accreditation?
If you work for an insurer – do you do any work with non-Lloyd’s brokers? If not, why not?
D Managing general agents

Chapter 5
A managing general agent (MGA) is an organisation which has been given authority on
behalf of an insurer to undertake a number of different tasks such as accepting risks, issuing
documents or handling claims. The authority is given using a type of contract called a
binding authority. The organisations acting as MGAs can be substantial in size, for example
DUAL underwrites over US$1.1bn of gross written premium annually which makes it larger
For reference only

than many of the individual syndicates in Lloyd's. MGAs can be located in London, other
parts of the UK, and around the globe.
These types of organisations are a very important part of the London Market's overall
distribution network, with, for example, over 30% of the annual premium income in the
Lloyd's market being received via these business partners. These organisations and
delegated authority generally will be studied more in LM2 and LM3.
A managing general agent (MGA) is an organisation which has been given authority on
behalf of an insurer to undertake a number of different tasks such as accepting risks, issuing
documents or handling claims. The authority is given using a type of contract called a
binding authority.
These types of organisations are a very important part of the London Market's overall
distribution network, with, for example, over 30% of the annual premium income in the
Lloyd's market being received via these business partners.
E International aspects of the London Market

Many of the organisations working within the London Market either have their roots or links
outside the UK. Many US insurers are now operating in the London Market either as a
company or via a Lloyd's syndicate as this provides them with the optimum platform to
access business from a worldwide client base. The Lloyd's brand provides value over and
above their own corporate brand.
In addition to insurers being international, the business coming into the London Market is
also truly international with only a relatively small proportion of business placed in both the
Lloyd’s and company markets originating in the UK.
Activity
See www.lloyds.com/lloyds/investor-relations for the latest Lloyd’s Annual Report and see
what it says in the opening pages about the geographic spread of business coming into
the market.
Compare this with the company market by looking at the latest International Underwriting
Association of London (IUA) statistics report: bit.ly/2x17nR6.
F Market associations
Various market associations represent the interests of particular sectors of the London
Market. In this section, we shall be looking at those which represent the syndicates, the
companies and the brokers.
F1 Lloyd’s Market Association (LMA)

The Lloyd’s Market Association (LMA) provides representation, information and technical
services to underwriting businesses (i.e. managing agents) in the Lloyd’s Market. All
managing and members’ agents are members of the LMA and are actively involved in its
work – participating on its board, committees or business panels.
The stated purpose of the LMA is to identify and resolve issues which are of particular
interest to the Lloyd’s underwriting community. The LMA works in partnership with the
Corporation of Lloyd’s and other partner associations, to influence the course of future
market initiatives.
Through associate membership (available to trading partners of Lloyd’s managing agents
and members’ agents) the LMA offers an information service to brokers, lawyers and similar
businesses connected with Lloyd’s.
As part of its service to members, access is provided to insurance policy wordings. These
carry the LMA’s copyright.
Chapter 5
Activity
Go to the LMA website (www.lmalloyds.com) and research any class of business in which
you are interested. See what the LMA groups are doing in relation to market reform, new
wordings and education.
For reference only

Ask your colleagues if they serve on LMA committees.
F2 International Underwriting Association of London (IUA)

The International Underwriting Association of London (IUA) is the world’s largest
representative organisation for international and wholesale insurance and reinsurance
companies. It exists to protect and strengthen the business environment for its member
companies operating in or through London. The IUA is a company limited by guarantee. It
has a Chief Executive and is governed by an elected Board, mainly comprising senior
market figures.
You might still hear references to two older company market trade bodies who merged to
form the IUA. The Institute of London Underwriters (ILU) represented marine and aviation
companies, and London Insurance and Reinsurance Market Association (LIRMA)
represented non-marine insurance and reinsurance interests.
An important distinction between the IUA and Lloyd’s is that the IUA is solely a
representative body and can exercise no control over the activities of its member
organisations, whereas Lloyd’s does have such ability to control and influence the activities
of both insurers and brokers working within that marketplace.
Table 5.1 lists the IUA’s priorities, according to its website.
Table 5.1: Priorities of the IUA

Priority Details
Process efficiency and business The IUA promotes the design and implementation of all aspects of market
attraction to London modernisation, including process reforms and electronic interfaces across
the market. This includes working on new processes for placing, claims
and accounting and settlement using ACORD standards as the preferred
format for data, in conjunction with leading organisation in the market.
Promoting expertise and innovation A full secretariat service is maintained to support the numerous
in underwriting and claims underwriting and claims committees which provide valuable technical
input and ideas of best practice to the benefit of the whole membership.
Influencing public policy and In recognition that insurance and reinsurance regulation is strengthening
compliance locally and converging globally, the IUA monitors and responds as
necessary to regulatory developments. The consequent compliance
activities are linked to the overall public policy work.
Activity
Review the IUA (www.iua.co.uk) website and investigate the different committees that are
involved with market activity – refer to the LMA website and identify which areas are
covered by joint committees.
If you work for an insurer, ask your colleagues if they serve on IUA committees.
Chapter 5
Question 5.6
The IUA exists to represent insurance companies operating in London. Which of
these is not one of its priorities?
a. Obtaining permission from overseas regulators for companies to write risks. □
For reference only

b. Maintaining dialogue with the broking community. □
c. Supporting underwriting and technical committees. □
d. Working on enhancing business efficiency. □
F2A Association of British Insurers (ABI)
The Association of British Insurers (ABI) is not a London Market body specifically but
some insurance companies with London Market operations will also be members. According
to its website, the ABI is the voice of the UK’s insurance, investment and long-term savings
industry with over 250 members, which together account for around 90% of premiums in the
UK domestic market.
The ABI’s role is to:
• bring the right people together to inform public policy debates, and to engage with
politicians, policymakers and regulators at home and abroad;
• be the public voice of the sector, promoting value and highlighting the importance of
insurance to the wider economy;
• encourage customer understanding of the sectors products and practices; and
• support a competitive insurance industry both in UK and abroad.
In addition, the ABI has an expert Research and Statistics Department and represents the
insurance industry to external audiences including the UK Government through its Media
and Political Affairs and European and International teams.
F3 Broker-related organisations
There are several different broker-related organisations and for the sake of completeness
they are all outlined here.
F3A British Insurance Brokers’ Association (BIBA)

BIBA is the major trade association for insurance intermediaries, with a membership of more
than 2,000; it is a non-statutory trade body.
BIBA draws its members’ attention to the need to comply with the fundamental principles that
govern the professional conduct of insurance brokers and intermediaries. Its rules
emphasise the need for members to conduct business with good faith and to represent the
best interests of their customers.
BIBA seeks to maintain and improve the highest standards of business behaviour and to
protect and enhance the interests of its members for the benefit of the general public. Its
mission statement is: ‘To represent and protect the best interests of our insurance
broker and intermediary members.’
According to its website, BIBA strives to achieve this by:
Promoting the services and contribution that insurance brokers and intermediaries provide
with advice, guidance and access to risk management and insurance
protection.
Influencing the relevant decision makers and policy writers that affect our sector.
Maintaining and developing a stable business environment in which our members operate by keeping them
informed of relevant issues, providing a forum for discussion and the exchange
of non-competitive information.
Chapter 5
Supporting members both collectively and individually through a series of facilities and support
services.
Activity
Review the BIBA website at www.biba.org.uk/JargonBuster.aspx. See what information it
For reference only

provides the public about the role of the broker and useful dictionary information for
consumers.
F3B London Market Regional Committee (LMRC)

The position regarding representation of London Market brokers is slightly complex.
The LMRC is integrated within BIBA's wider regional structure to represent the interest of
brokers operating in the London and worldwide re/insurance markets.
The intention is to maintain a lobbying role and to represent the sector to the UK regulators,
Europe, the UK Government and other stakeholders. It aims to work with other London
Market bodies, including LIIBA, on areas of mutual interest and to avoid duplication of work.
F3C London and International Insurance Brokers’ Association (LIIBA)
London and International Insurance Brokers’ Association (LIIBA) is an independent
trade body, representing the interests of insurance and reinsurance brokers operating in the
London and international markets. It was set up in 2009 when BIBA changed its London
Market representational committee structure.
LIIBA’s mission is to ensure that London remains where the world wants to do business by
continuing the transformation of market processes and maintaining the highest professional
standards.
LIIBA’s key priorities are:
• Representing members’ interests to Government, the regulators, the EU and international
bodies to establish a proportionate regulatory framework.
• To modernise the London Market’s business processes to be competitive and efficient,
delivering an improved client service.
• Supporting members with regarding legislative and technical changes.
F4 Managing General Agents Association (MGAA)

The Managing General Agents Association (MGAA) provides specific representation on
behalf of MGAs in the insurance market, to be their voice and to drive best practice within
the industry. According to the MGAA, managing general agents who hold delegated
underwriting authority on behalf of both Lloyd's and company market insurers write in excess
of £6bn gross written premium.
The organisation has some key objectives.
The MGAA will:

• Convey the views of its members to UK and European parliaments, government
departments, regulators and other relevant insurance organisations
• Represent members’ interests in negotiations with bodies whose rulings, regulations
or controls may impact members Set best practice guidelines to assist members in
ensuring the stability, security and reputation of their MGAs
• Set best practice guidelines to assist members in ensuring the stability, security and
reputation of their MGAs
• Assist insurance carriers that support MGAs to maintain the stability, security and
reputation of their binding authority arrangements
• Work proactively to improve the MGA sector’s professionalism, stability and
Chapter 5
competitiveness
• Create a technical centre providing commentary, information and guidance on relevant
regulatory developments
• Promote the UK MGA sector through good PR and communications
• Seek opportunities to promote training, education and high standards of products and
For reference only

services
• Listen to its members and develop beneficial services for MGAs
Source: www.mgaa.co.uk
G Flow of business in the London Market

Refer to
The roles of the broker and the underwriter are covered in more detail in chapter 8
and Functions of an underwriter on page 9/2
In this section, we will see how business flows through the London Market both as part of the
placing and claims process.
Let us start, however, by considering briefly why business comes to the London Market in
the first place.
London is one of many international insurance markets which are freely available to brokers
and insureds to access should they so choose. However, for a number of reasons, London is
felt to be a leading world insurance market, as follows:
• Capacity. Insurers in London have the ability to take on large risks and the subscription
nature of the market means that even the largest of risks can be underwritten within the
market.
Subscription market
This term means that the risk is generally shared between two or more insurers rather
than written 100% by one insurer.
• Entrepreneurial spirit. Loosely translated as being prepared to look at new aspects of

risk transfer. The insurer works with an insured and their broker to put together a product
which suits the client, rather than trying to shoe-horn them into an existing product.
• Good claims service using knowledgeable personnel. The claims service is the shop
window of any insurer or market and London is no different in this respect.
• History and experience. The London Market can channel over 300 years of history and
can use its prior knowledge and experience to its advantage when looking at new risks.
Consider this…
One of the London Market’s current challenges is that its processes can be quite unwieldy,
thus rendering it less efficient than other marketplaces. If those other marketplaces can
offer capacity, knowledge and service combined with efficiency, then they might win
business.
Use this link to find out more about the Future at Lloyd's project and consider how it might
have positive effects:
www.lloyds.com/about-lloyds/future-at-lloyds.
G1 Placing a risk
The broker puts a summary of the risk to be placed and the suggested terms and conditions
onto a document called a Market Reform Contract (MRC; still known as a ‘slip’). The content
and format of this document is governed by clear market rules – in an attempt to obtain both
standardisation and clarity as early in the process as possible.
Chapter 5
Both Lloyd’s and the London Market, in general, have adopted specific procedures designed
to ensure that all parties are fully aware of the coverage and terms of the policy before a risk
starts to be covered. This was originally developed as part of an initiative known as ‘London
Market Principles (LMP)’ but has been widened to the whole market and is referred to as
contract certainty.
For reference only

The reason for the initiative was that there was a practice of ‘deal now and detail later’ which
led to some major issues when the detail had not been dealt with before the arrival of
a claim.
The following definition for contract certainty has been agreed:
Contract certainty is achieved by the complete and final agreement of all terms between
the insured and the insurer by the time that they enter into the contract, with contract
documentation provided promptly thereafter.
To outline, the full wording must be agreed before any insurer formally commits to the
contract. The market has decided that appropriate evidence of cover must be issued within
30 days of inception. This can be a formal policy, a copy of the market reform contract/slip or
broker-produced evidence of cover such as a Broker Insurance Document (BID) or similar.
Note the following points:
• For those transactions that involve a broker, the broker obtains a quotation from an
underwriter who is a recognised ‘leader’ in a particular class of business. The key is
finding a leader who will both provide a good quotation for the client but who also enjoys
the support and confidence of the rest of the market:
– this underwriter will indicate the percentage share that they will accept and the terms
that will apply;
– a good broker will seek several quotes for the business from a variety of different
leaders if available. Once obtained, the broker should advise their client as to any
differences between the quotes and offer guidance as to which is the most
appropriate, taking into account the client’s requirements; and
– once the customer has decided which quote to accept, then the broker has, what is
known as, a firm order for the business.
• Having received the firm order, the Lloyd’s broker approaches other underwriters and
‘fills’ the MRC/slip by obtaining signatures for the shares of the risk that they are each
willing to accept. The broker can use any market they choose: Lloyd’s, London
companies or the international market – there is no restriction on them other than to
obtain the best deal for their client.
• Once the MRC/slip is fully placed (in other words, the percentages accepted by each
underwriter total the amount of cover required), the risk must then be submitted centrally
for recording on the central market database and the premium paid to the London Market
insurers. The broker uses a system known as Accounting and Settlement (A&S) to submit
all the documents electronically to Xchanging Ins-sure Services (XIS) (now part of
DXC). This system and process is discussed further in chapter 8 and in the LM2
study text.
• The underwriters usually agree that the broker can deduct a certain percentage of the
premium (this deduction is called ‘brokerage’). Therefore, the amount of money that is
taken from the broker account for transmission to the underwriters will be the net
amount.
Example 5.2
The underwriter quotes a premium on the slip – called the gross premium – indicating the
deduction or brokerage that the broker can take.
The calculation is gross premium minus brokerage = net premium paid to underwriters.
So, if underwriter quotes a gross premium of £1,000 and indicates a brokerage of 20%,
the net premium would be £800 (£1,000 – £200 = £800).
In many risks there will be taxes involved as well, and it is important to understand how
the tax and other figures interact. Generally speaking, the calculation of brokerage is done
Chapter 5
without any reference to tax. For example:

Gross premium of £1,000 and brokerage of 20%. Insurance premium tax also payable by
the insured of 6% of gross premium. The amount that the insurer should receive is
calculated as follows:
Gross premium £1,000 less 20% brokerage = £800 net premium.
For reference only

Tax is 6% of £1,000 = £60.
Total payable to insurers is £800 + £60 = £860.
• XIS records the risk and premium details on the central market databases for both the
Lloyd’s and company market underwriters. It facilitates the payment of the premium to
both Lloyd’s and London company underwriters for the broker.
• A formal policy is not always required, but if one is required the underwriters have the
option of producing it themselves or requesting that XIS produce it for them (Lloyd’s and
companies – the policies will be separate).
• Once the data is recorded and the premium paid, both the broker and the underwriters
will get electronic messages from XIS with data about the risk.
Question 5.7
If an underwriter quotes a premium of £5,000 and allows brokerage of 25%, how
much will the underwriter receive in their bank account when the premium is paid?
a. £5,000. □
b. £1,250. □
c. £3,750. □
d. £4,000. □
Intelligent Market Reform Contract (IMRC)

Significant work has been done recently on the Core Data Record. This is the critical
transaction related data that is required at the point the contract is concluded to allow
downstream processes to take place such as:
• premium validation and settlement;
• claims matching at first notification of loss;
• tax validation and reporting; and
• regulatory validation and core reporting.
It is intended that in time, these pieces of data will be entered into the IMRC and
placement platforms and form the fundamental single record of the contract entered into.
Activity
Speak to colleagues and find out what involvement your company has had so far in this
work if any.
Use this link to find out more: https://lmg.london/news/data-council-launches-consultation-
on-imrc/.
G2 Presenting a claim
Chapter 5
• Once the broker receives a claim notification from their client they need to identify the
correct combination of insurers that are required to see and agree the claim (they
are called the Agreement parties). The London Market operates under a set of claims-
handling agreements (one set for Lloyd’s and one for the IUA). This will be discussed in
more detail in chapter 8.
For reference only

• The broker then decides whether they wish to present the claim in paper form or
electronically using an Electronic Claims File. If they choose the latter, the broker enters
all the data and loads the documents onto the system rather than presenting a paper file
or more commonly sending emails to the insurer. However, they can still meet face-to-
face or via video call with the insurers to assist with negotiation and settlement of
the claim.
• The broker presents the claim and the data is circulated to all the London Market insurers
participating on the risk (even those who are not involved in the claims handling/
agreement process) using Xchanging systems.
• If the insurers instruct any experts this is often done through the broker and the broker
acts as a conduit to pass on information and reports between the insurers and the
experts as well as the insurers and the clients (insureds).
• If there are any settlements to be made, then once the correct combination of
underwriters (known as the Agreement parties) have agreed to the presentation, the
money again moves electronically from the insurers’ bank accounts to the broker (or
perhaps directly to a third-party expert such as a lawyer depending on the claim).
• Electronic messages are sent to both insurers and the broker by the Xchanging systems
– detailing the transactions, the claims attached and the applicable policy references.
• Once the broker receives any claims monies they forward them to their client to finalise
the claim.
Key points
Lloyd’s
• Lloyd’s is not an insurer itself, but a marketplace which provides some structure and
regulation for the organisations working within it.
• The investors in Lloyd’s are called Names or members and they group together into
syndicates.
• The Names or members can be individuals or corporate entities.
• Syndicates only exist for a year but their accounts are not finalised for three years.
• Most capital coming into the Lloyd’s Market today is corporate in nature rather than
individual.
• The syndicates are run by managing agents. One managing agent can run more than
one syndicate.
• Members’ agents work for Individual Names or members and advise them on their
investment in the Market.
• Some insurance companies also have Lloyd’s syndicates.
Company market
Chapter 5
• The company market comprises insurance companies which have shareholders rather
than Names.
• Mutual insurers are groups where the insureds pool together to insure each other using
professional managers to run the business.
For reference only

• Captive insurers accept risks from only one source, usually companies within the
same group.
• It is possible for an insurance entity to have both an insurance company and a Lloyd’s
syndicate within the group.
Managing general agents
• An MGA is an organisation that has authority delegated to it by insurers to do a

number of tasks such as accepting risks or agreeing claims.
• Some MGAs are larger in premium income terms than individual insurers.
Brokers
• Brokers are professional intermediaries and act as the agent of the re/insured in both
the placing and claims process.
• They must be authorised by the regulators, but brokers can also apply to Lloyd’s to be
accredited as a Lloyd’s broker.
International aspects of the London Market
• The London Market is international both in the sources of capital and in the
customer base.
Market associations
• The IUA is the representative body for the company market but has no control over the
activities of its members.
• The LMA provides representation, information and technical services for the managing
and members’ agents working in the Lloyd’s Market.
• LIIBA is an independent trade body, representing the interests of insurance and
reinsurance brokers operating in the London and international markets.
• The market bodies work together on many projects such as wordings.
• There are a number of different broker-related organisations:
– British Insurance Brokers’ Association (BIBA);
Key points
– London Market Regional Committee (LMRC); and
– London and International Insurance Brokers’ Association (LIIBA).
• The MGAA is the trade body for managing general agents in the UK, who represent
both Lloyd’s and company insurers.
Flow of business in the London Market
• Reasons for coming to the London Market:

– large capacity;
– a subscription market where risks are shared between insurers;
– long history and significant knowledge in the market;
– London Market insurers are entrepreneurial in nature; and
– market provides good claims service.
• The broker presents the risk to insurers who if they are prepared to accept it will
indicate their agreement on the slip or MRC.
• The broker will receive the premium from the client and pay to insurers less any
brokerage that insurers allow the broker to keep.
• Xchanging/DXC maintains central market databases for both premiums and claims and
Chapter 5
moves money for the market through central settlement systems.
• Claims are presented to insurers and, if agreed, funds will usually be paid via
the broker.
For reference only

Question answers
5.1 a. The Council of Lloyd's.
5.2 d. One year.
5.3 b. Corporate capital.
5.4 b. The members' agent.
5.5 b. Captive insurer.
5.6 a. Obtaining permission from overseas regulators for companies to write risks.
5.7 c. £3,750.
Chapter 5
For reference only

Self-test questions
1. What is the term used for the investors in the Lloyd's Market?
a. Shareholders. □
b. Members. □
c. Insurers. □
d. Agents. □
2. What is the difference between a syndicate and a managing agent?
a. The syndicate bears the risks and the managing agency runs the day to day □
business.
b. They are two terms for the same thing. □
c. The managing agency bears the risk and the syndicate runs the day-to-day □
business.
d. The syndicate is regulated and the managing agency is not. □
Chapter 5
3. What is the role of the Council of Lloyd's?
a. To set the business plans for the market. □
b. To run the central market systems. □
For reference only

c. To directly engage with overseas regulators. □
d. Management and supervision of the Lloyd's market. □
4. Who do Lloyd's Names use as their professional advisers when deciding to invest in
the market?
a. Members' agents. □
b. Brokers. □
c. Managing agents. □
d. Solicitors. □
5. What is meant by the term 'premium income limit'?
a. A measure of the size of the insurer based on how much business it can accept in □
a year.
b. How much premium any individual client can be asked to pay. □
c. How little premium any individual client can be asked to pay. □
d. The target set by the regulators for insurers each year. □
6. Which type of insurer typically specialises in risks such as shipowners' liability?
a. Lloyd's syndicate. □
b. Mutual indemnity association. □
c. Limited liability company. □
d. Service company. □
7. For whom is the broker usually working in the London Market?

a. The insurer. □
b. The insured. □
c. Whichever party contracts their services first. □
d. Both insurer and insured. □
8. Which section of the market does the LMA represent?
a. Mutual indemnity associations. □
b. Insurance companies. □
c. The regulators. □
d. Managing agents. □
9. Which main body represents brokers operating in the London Market?
a. ABI. □
Chapter 5
b. IUA. □
c. LIIBA. □
d. LMA. □
For reference only

Legal and regulatory
6
environment
outcomes
Introduction
A Overview of the UK regulatory framework 7.1
B Operation of the FCA and PRA 7.1
C Overseas regulation 7.2
D Lloyd’s Market governance 7.3
E Authorisation of new insurers 7.5
F The Financial Ombudsman Service (FOS) and Financial Services 7.4
Compensation Scheme (FSCS)
Key points
For reference only
Chapter 6
Question answers
Self-test questions
Learning objectives
• describe the aims and approach to regulation of the insurance industry;
• describe the role of the UK and major international regulators;
• explain the governance of the Lloyd’s Market;
• explain the role of the Financial Ombudsman Service (FOS) and the Financial Services
Compensation Scheme (FSCS); and
• explain how insurers become authorised.
Introduction
In this chapter, we will be looking at some of the basic regulatory structures that exist to
control the way in which the insurance market operates in the UK and internationally. This
control starts from the approval of new insurers into the business and flows through to the
compensation schemes that can apply should an insurer not be able to pay claims. We will
also look at the methods by which insurers based in London are permitted to insure risks
from other countries, and the regulation that Lloyd’s is permitted to perform within its own
marketplace.
Key terms
Admitted basis Capital adequacy Central Fund Commercial

customer
Conduct risk Consumer Fair treatment of Lloyd’s Market
customers governance
Primary rules: Protected Run-off Secondary rules:
byelaws and disclosures requirements
regulations
Surplus lines basis Whistle-blowing
A Overview of the UK regulatory framework

The UK regulatory framework for financial services consists of three regulatory bodies:
For reference only

Financial Conduct Authority (FCA)
Chapter 6
• Separate independent regulator responsible for conduct of business and market issues
for all firms and prudential regulation of small firms, like insurance brokerages and
financial advisory firms.
• Focused on taking action early, before consumer detriment occurs.
• Shift towards thematic reviews and market-wide analysis to identify potential problems in
areas such as financial incentives.
• Reviews the full product lifecycle from design to distribution with the power to ban
products where necessary.
Prudential Regulation Authority (PRA)
• Sits within the Bank of England and is responsible for the stability and resolvability of
systemically important financial institutions such as banks, building societies and
insurers.
• Will not seek to prevent all firm failures but will seek to ensure that firms can fail without
bringing down the entire financial system.
• Will place emphasis on ‘judgment based’ approach to supervision focusing on: the
external environment, business risk, management and governance, risk management
and controls and capital and liquidity.
Financial Policy Committee (FPC)
• A committee within the Bank of England responsible for horizon scanning for emerging
risks to the financial system as a whole and providing strategic direction for the entire
regulatory regime.
Reinforce
The PRA is responsible for solvency and stability of those institutions which are felt to be
important to the financial services industry as a whole such as banks and insurers.
The FCA takes care of consumer protection and market regulation.
The FPC watches for systemic risks – i.e. those risks that can impact the whole industry.
Chapter 6 Legal and regulatory environment 6/3
B Operation of the FCA and PRA

In this section, we will examine the way in which the regulators carry out their supervision,
authorisation and regulation of the insurance industry. In line with the exam syllabus, we will
be looking only at the high level concepts of regulation here.
B1 Operation of the Prudential Regulation Authority

B1A Objectives of the PRA
The PRA has a primary objective to ‘promote the safety and soundness of PRA
regulated persons’.
It also has secondary objectives:
• Ensuring that PRA authorised persons behave in a way which avoids adverse effect on
the stability of the UK financial system.
• Minimising the adverse effect that the failure of a PRA-authorised person could be
expected to have on the stability of the UK financial system.
• Facilitating competition (but note that this is subordinate to the primary objective of
promoting the safety and soundness of PRA regulated persons).
Additionally, the PRA has very specific objectives and responsibilities in relation to the
insurance industry which are:
• ‘Contributing to the securing of an appropriate degree of protection for those who are or
may become policyholders’.
• ‘An appropriate degree of protection for the reasonable expectations of policyholders as
to the distribution of surplus under with-profits policies’.
For reference only

Be aware
Chapter 6
A with-profits policy is one with certain characteristics such as:
• A share in certain of the profits or losses of the insurer.
• Certain guarantees, which usually increase over the lifetime of the policy.
For example the payment of a guaranteed amount at maturity or retirement, or on death.
B1B Threshold conditions

Every firm regulated by the PRA, such as insurers, must meet minimum conditions before it
will be permitted to carry on regulated activities. These are designed to promote safety and
soundness and include:
• A firm’s head office, and in particular its mind and management, to be in the United
Kingdom.
• A firm’s business to be conducted in a prudent manner – and that the firm maintains
appropriate financial and non-financial resources.
• The firm itself to be fit and proper and be appropriately staffed.
• The firm and its group to be capable of being effectively supervised.
B1C Risk assessment framework
The PRA’s framework involves three elements:
• Potential impact on policyholders.
• The macroeconomic and business risk context in which the firm operates.
• Any mitigating factors including risk management and governance.
The intensity of the supervision will depend on their perceived level of risk but all firms will be
facing a baseline level of monitoring which will include:
• Ensuring compliance with prudential standards for capital.
• Liquidity, asset valuation, provisioning and reserving.
• At least an annual review of the risks posed by firms or sectors to the PRA’s objectives.
• Assessing a firm’s planned recovery actions and how it might exit the market.
The PRA will be constantly assessing any firm’s proximity to failure, and will be measuring
using the supervisory framework as shown in Table 6.1.
Table 6.1: PRA supervisory framework

Gross risk Safety and soundness
1. 2. Risk context 3. Operational mitigation 4. Financial mitigation 5. Structural

Potential mitigation
impact
Potential External Business Risk Management Liquidity Capital Resolvability

impact context risks management and governance
and controls
Source: this table has been reproduced by kind permission of the Prudential Regulation Authority
For each of the issues identified in the framework such as liquidity and capital, there will be
five different stages on what is known as the Proactive Intervention Framework (PIF), each
coming closer to failure and if a firm moves into a higher stage in any category, the
supervisors within the PRA will be considering their next steps and the management of the
firm will be expected to take remedial action to reduce the likelihood of failure.
B2 Operation of the Financial Conduct Authority

B2A Objectives
The FCA has an overarching strategic objective to ‘ensure that the relevant markets
function well’.
It also has three operational objectives:
For reference only

• Consumer protection: securing an appropriate degree of protection for consumers.
Chapter 6
• Integrity: protecting and enhancing the integrity of the UK financial system.

• Competition: promoting effective competition in the interests of consumers in the
markets for:
– Regulated financial services.
– Services provided by a recognised investment exchange.
In addition, both the FCA (and the PRA) must have regard to:
• Efficient and economic use of resources.
– Proportionality.
– Consumer responsibilities.
– Transparency.
The FCA also has responsibility for the Financial Ombudsman Scheme and the Financial
Services Compensation Scheme.
B2B The FCA’s involvement in authorisations and approvals
The FCA focuses on the proposed business model, governance and culture, as well as the
systems and controls the firm intends to put in place, especially over:
• product governance;
• end-to-end sales processes; and
• prevention of financial crime.
The FCA works closely with the PRA in considering applications to approve individuals to
roles which have a material impact on the conduct of a firm’s regulated activities. The FCA
will seek to assess that applicants have a good understanding of how to ensure good
outcomes through:
• corporate culture;
• conduct risk management; and
• product design.
B2C FCA approach to regulation

The FCA intends to be more proactive than previous regulators and will intervene earlier in a
product’s life and seek to address the root causes of problems for consumers. Additionally, it
is also a body able to review and deal with detailed submissions made by consumer groups
(formerly only performed by the Office of Fair Trading).
The FCA’s competition objective means that it wants firms to innovate and produce new
products but will be watching for those types of innovation that exploit customers as
contrasted with those that genuinely meet customers’ needs.
B2D FCA approach to supervision
The general principle is that businesses are encouraged to base their business model,
culture and day-to-day running on the ethos of treating customers fairly. The FCA defines
firms as either 'fixed portfolio' or 'flexible portfolio' firms and their regulatory approach differs
between the two in practical terms.
Fixed portfolio firms are a small population of firms (out of the total number regulated by
FCA) that, based on factors such as size, market presence and customer footprint, require
the highest level of supervisory attention. These firms are allocated a named individual
supervisor, and are proactively supervised using a continuous assessment approach.
The majority of firms are classified as flexible portfolio firms. These are proactively
supervised through a combination of market-based thematic work and programmes of
communication, engagement and education activity aligned with the key risks identified for
the sector in which the firms operate. Flexible portfolio firms use the FCA Customer Contact
Centre as their first point of contact with FCA as they are not allocated a named individual
supervisor. Contact Centre staff should have the expertise to deal with the majority of issues
and queries, and these will be passed onto the appropriate supervision area where
necessary.
For reference only

B2E Risk framework
Chapter 6
The FCA has a three pillar approach to risk, and these pillars are:
• Firm systematic framework – which involves asking the question as to whether the
interests of the customer are at the heart of the way the business is run.
• Event driven work – flexible supervisory activity driven by issues that are emerging or
have recently happened.
• Issues and products – flexible approach which allows the FCA to look at reviews of
issues and products as they take place.
B2F What can the FCA do if it finds problems?
The FCA can take a number of steps in response to issues including but not limited to:
• banning products in the retail sector;
• withdrawing misleading financial promotions; and
• fining or prosecuting individuals and organisations.
B2G Who will the FCA be answerable to?
The FCA is required to report to Government and Parliament annually as well as engage
more with consumers directly. It will have to put in place four statutory panels representing
the view of consumers, regulated firms, smaller regulated firms and market practitioners.
B3 Practical matters relating to both the FCA and PRA

B3A FCA Handbook and PRA Rulebook
The two reference documents are the FCA Handbook and PRA Rulebook. These contain
material that was inherited when the FCA and PRA replaced the previous regulator in 2013,
together with additional material created as required to reflect more recent changes,
including the UK leaving the EU.
B3B Working together
There is a statutory duty for both the FCA and PRA to work together and to co-ordinate their
activities, to have a cross membership of their various boards, and to create a memorandum
of understanding of how they are interlinked. The PRA also has a power of veto to prevent
the FCA doing something, because financial stability can take precedence over consumer
protection at times of economic stress.
B4 Principles for Businesses (PRIN)

There are eleven Principles for Businesses that have to be met. These Principles are now
part of both the PRA Rulebook and FCA Handbook, as follows:
Principles for Businesses (PRIN)
Principle Detail
1. Integrity A firm must conduct its business with integrity.
2. Skill, care and diligence A firm must conduct its business with due skill, care and
diligence.
3. Management and control A firm must take reasonable care to organise and control its
affairs responsibly and effectively, with adequate risk
management systems.
4. Financial prudence A firm must maintain adequate financial resources.
5. Market conduct A firm must observe proper standards of market conduct.
6. Customers’ interests A firm must pay due regard to the interests of its customers and
treat them fairly.
7. Communications with clients A firm must pay due regard to the information needs of its clients,
and communicate information to them in a way which is clear, fair
and not misleading.
8. Conflicts of interest A firm must manage conflicts of interest fairly, both between itself
and its customers and between a customer and another client.
For reference only

9. Customers: relationships of trust A firm must take reasonable care to ensure the suitability of its
Chapter 6
advice and discretionary decisions for any customer who is

entitled to rely upon its judgment.
10. Clients’ assets A firm must arrange adequate protection for clients’ assets when
it is responsible for them.
11. Relations with regulators A firm must deal with its regulators in an open and cooperative
way, and must disclose to the FCA appropriately anything relating
to the firm of which that regulator would reasonably
expect notice.
Note: The PRA applies Principles 1 to 4, 8 and 11 only. © Financial Conduct Authority
Separate sections in the regulators’ Handbooks develop each of these themes more fully.
Some principles are expected to be embedded in a firm’s operations and procedures and
effectively be business as usual, e.g. fair treatment of customers – formerly the TCF
initiative.
Activity
Consider whether the following behaviours might give rise to a conflict of interest (see
Principle 8). Write ‘yes’ or ‘no’ alongside each one first, then ask colleagues for their input.
• A broker retaining clients’ money before paying on to insurers.
• Accepting corporate hospitality or gifts.
• A single broker or claims adjuster dealing with claims from two or more clients arising
out of the same loss.
• A broker having any authority from an insurer to settle claims.
B5 Fair treatment of customers

The customers are the key to an insurer or a broker's success and without them the
organisation would find it difficult to survive. Investors want to receive a return on their equity
and to ensure this is achieved, the organisation needs to make a profit. However, to do so at
the expense of the customer base, regardless of size, would not be a particularly successful
ongoing business model. This is particularly the case in a marketplace which is generally
oversupplied with insurance capacity, thus allowing customers the opportunity to take their
business elsewhere.
Principle 6 states that ‘a firm must pay due regard to the interests of its customers and treat
them fairly’.
The FCA expects those authorised to be able to show consistently that fair treatment of their
customers is at the heart of their business model. They have defined this to mean
addressing the fair treatment of customers throughout the product life-cycle, as follows:
product
design and
governance
identifying
complaint
the target
handling
market
after-sales marketing and

information promoting the
product
sales and
advice
process
‘Fairness’ covers a series of values and depends on the specific circumstances of each
For reference only

case. The FCA’s principles-based approach means there is no prescriptive checklist for
Chapter 6
compliance with this requirement. However, it has issued guidelines on what is (and what is
not) appropriate behaviour. Remember that the FCA’s primary focus is the protection of
consumer customers rather than large commercial clients who are expected to be more
sophisticated in their knowledge both of insurance and the products on offer.
Vulnerable customers have been of particular focus recently. The COVID-19 pandemic has
highlighted that a customer might become temporarily vulnerable at a particular point in
because of other external factors such as illness or bereavement as well as being vulnerable
on a more permanent basis through factors such as language barriers.
On the Web
• FCA guidance on vulnerable customers: www.fca.org.uk/publication/finalised-guidance/
fg21-1.pdf.
• Financial Vulnerability Taskforce resource library: www.fvtaskforce.com/resource-
library.
Activity
What would you personally consider to be unfair behaviour by an insurer? Think about
product information, the sales process and the claims process. Ask six friends not
involved in the insurance business whether they have ever had an experience with an
insurance company that they considered to be unfair and make some notes as to what
behaviour they felt was unfair.
In your view, were all of the ‘unfair’ experiences described by your friends truly unfair? Do
any of them simply represent an outcome with which your friend (the customer) disagreed
– but which was actually fair?
Many insurance-related products are complex and the level of consumer understanding is
relatively low unless the consumer happens to also work in the insurance industry.
This means that there could potentially be times when a customer is satisfied simply
because they do not realise that they have been unfairly treated. On the other hand, a
customer who had unrealistic expectations may be dissatisfied, even though the firm knows
that it has treated them fairly.
Consider this…
An insured purchases a policy and receives with it documentation setting out clearly what
is covered and what is excluded. They do not bother to read the documentation.
Sometime later they have a loss and make a claim. The insurer declines the claim
because there is a clear exclusion in the policy and sets the reasons out clearly in a
covering letter.
The insured complains because they did not expect any claims to be declined.
Do you consider that the insurers have treated them fairly by firstly providing clear
supporting material at the time of placement and then with the letter setting out the
reasons for the claim being declined?
A firm, whether it’s an intermediary or insurer dealing directly with clients, must develop
procedures out of an adequate knowledge of the markets and its particular expertise in
creating appropriate solutions for its clients. Where a customer is known to be less
knowledgeable, the firm must explain things in greater detail.
For all clients, it is necessary to understand their needs and to meet those needs with the
most appropriate product.
Consumers and commercial customers

The FCA draws a distinction between two different types of clients.
A consumer is defined as a natural person who is acting for purposes which are outside
their trade or profession.
For reference only

Chapter 6
A commercial customer is a customer who does not fall into the consumer definition.
This is an important distinction as there are different rules and obligations to customers
under FCA rules depending on whether they are one type or the other.
Here are some examples of the distinction:
• Individual purchasing personal motor insurance is a consumer.
• Individual purchasing motor insurance for all the cars owned by their company would
be a commercial customer.
• Individual buying house insurance for their home is a consumer.
• Individual buying house insurance for a property bought to let out is a commercial
customer.
This distinction is very important particularly in relation to concepts such as the fair
treatment of customers which apply only to consumers but are of course good practice to
apply to commercial customers as well.
Promised service levels must be delivered to customers so that they are protected from
unpleasant surprises arising from the products they buy.
When developing a new product the FCA requires a firm to identify its inherent level of risk. It
is the FCA’s view that customers should not be exposed to unsuitable or unidentified risks
arising from a newly developed product. A firm must treat its customers fairly and have
appropriate controls in place to ensure this is the case.
A good example of a new product would be a contract where the firm actually delegates
some underwriting authority to someone else (perhaps a broker). This type of contract (often
known as a binding authority) carries more risk for the insurer as it is allowing day-to-day
control of the contract out of its own hands.
The FCA is not expecting customised products for each customer, otherwise the market
would grind to a halt owing to soaring costs. However, the FCA expectations mean that a
firm must consider its target market. The systems and controls it puts into place must be
such that they ensure the firm’s actions are likely to be fair for that target market.
Consumer responsibility
Note that the FCA also expects consumers to take responsibility for their decisions where
they have the understanding and information to do so.
Activity
Imagine you are putting together a product covering personal possessions for students in
halls of residence. Consider what you should do to ensure that you cover all the
requirements of the fair treatment of customers.
Conduct risk
Lloyd’s has produced a set of Principles which are tailored to the operation of the Lloyd’s
market. They deal directly with how best to treat customers fairly and they apply to all
customers – both consumers and businesses. However, the different level of
understanding of insurance by a consumer and a business should be recognised, hence,
insurers’ behaviour towards each group must take this into account, for example, by the
way in which they communicate.
Use this link and look at the Principle on customer outcomes: www.lloyds.com/conducting-
business/market-oversight/principles-for-doing-business-at-lloyds/customer-outcomes.
B5A Consumer Duty

In 2021 the FCA commenced a consultation on a new Consumer Duty which reinforces
many of the requirements already in place. It is aimed at any organisation which is involved
in the manufacture or supply of products or services to any retail clients which broadly
means consumers or SMEs.
For reference only
Chapter 6
The expectation from the regulator is that firms put themselves in their customers shoes and
consider whether they would be happy with the treatment received or whether they would
recommend them to others.
What concerns the FCA is that they continue to see behaviours which can cause consumer
harm such as:
• providing information in a way which is difficult for the consumer to understand and
therefore make an informed decision;
• offering products which are not fit for purpose or appropriate for the targeted customer
base;
• offering products which are not fair value – i.e the benefits are not reasonable in relation
to the price paid;
• poor customer service; and
• other behaviours which take advantage of things, such as customer inertia (such as
unwillingness to look around for better deals).
The FCA has already issued requirements to firms around pricing, for example ensuring that
a renewing customer does not pay more than a new customer would for the same product in
the same context.
Be aware
The FCA has now established a new Principle 12 ('A firm must act to deliver good
outcomes for retail customers') to implement the Consumer Duty in July 2022, with full
implementation expected by 31 July 2023.
B6 Senior Management Arrangements, Systems and

Controls (SYSC)
These provide greater definition of Principle 3. Every regulated firm must take reasonable
care to share out the significant responsibilities within the firm between its directors and
senior managers so that:
• it is clear who has which responsibility; and
• the business of the firm can be adequately monitored and controlled by the directors,
senior managers and the board.
There is a requirement within SYSC for insurers and intermediaries to appoint a money
laundering reporting officer (MLRO) who has overall responsibility within the firm for the
establishment and maintenance of effective anti-money laundering systems and controls.
Refer to
Money laundering is dealt with in more detail in Anti-money laundering on page 7/14
Money laundering is quite simply the process by which criminals attempt to conceal the
origins of the proceeds of crime.
Activity
Find out who the MLRO is in your firm and what they do.
Also within SYSC is the Senior Managers and Certification Regime (SMCR).
B7 Public Interest Disclosure Act 1998 (PIDA)
For reference only

Chapter 6
The Public Interest Disclosure Act 1998 (PIDA) concerns ‘whistle-blowing’, which is the
public allegation of a firm’s concealed misconduct, usually from within the same
organisation. Put rather more childishly, it could be likened to telling tales, although the
subject-matter is generally far more serious.
The Act was born out of a desire to encourage a culture of openness within an organisation
on the basis that prevention is better than cure.
PIDA states that individuals who make qualifying disclosures of information in the public
interest have the right not to suffer detriment by any act or omission of their employer
because of the disclosure. The technical term for ‘whistle-blowing’ is ‘making a qualified
disclosure’.
Protected disclosures
The PIDA makes it unlawful for an employer to punish an employee (for example,
terminate their employment) for whistle-blowing as long as the report was made in
good faith.
The term protected disclosure is used to define a qualifying disclosure made by an
employee and links PIDA with employment rights legislation so as to ensure that
employees making qualified disclosures cannot be discriminated against by reason of
having made that disclosure.
A qualifying disclosure is one which, in the reasonable belief of the worker, tends to show
that one or more of the following has been, is being, or is likely to be committed:
• a criminal offence;
• failure to comply with any legal obligation;
• miscarriage of justice;
• putting off health and safety of any individual in danger;
• damage to the environment; and
• deliberate concealment of any of the above.
Application of PIDA
PIDA does not just apply to the financial services industry. For example, say a factory
owner deliberately fails to provide appropriate safety equipment (such as gloves, steel
toecap boots or guards on machinery) to staff performing a dangerous task. In this case,
the whistle-blower should go to the Health and Safety Executive to report the factory
owner.
Firms are encouraged by the FCA to adopt appropriate internal procedures encouraging
workers to ‘blow the whistle’ internally when they are concerned about FCA-related matters.
However, a wise employer would not restrict this solely to FCA issues.
For a larger firm, such appropriate internal procedures may include a statement of intent that
the firm takes failures seriously and which indicates what it regards as a failure. Written
procedures should show respect for the confidentiality of workers who raise concerns and
describe how such concerns may be raised (outside the usual management structure and, if
necessary, outside the firm).
The firm should consider offering access to an external body, such as an independent
charity, for advice. The procedures should also describe the penalties for making false and
malicious allegations and ensure that once a worker has made a protected disclosure they
are not victimised. In addition, they should make their whistle-blowing procedures accessible
to staff of their key contractors.
The FCA acknowledges that a less wide-ranging set of procedures may be appropriate for
smaller firms.
Activity
Locate your company’s whistle-blowing procedures and familiarise yourself with them.
For reference only
Chapter 6
Question 6.1
An insurer refuses to purchase employers' liability insurance even though it is
compulsory by law. If an employee reports their employer to the appropriate
authorities for this breach, what is this technically known as?
a. Making an appropriate report. □
b. Whistle-blowing. □
c. Making a qualifying disclosure. □
d. Collaborating. □
B8 Environmental, social and governance (ESG)
This concept is far wider than just concerns about climate change, albeit that is a major part
of it. From regulators down to individual stakeholders such as investors or customers, there
is an increasing need for businesses to consider both their own strategy and also how the
strategy of their clients or business partners, impacts their willingness to do business with
them.
For example, the FCA have indicated these as being some of the key themes in their work
programme:
• Promotion of global standards for sustainability reporting.
• Improved transparency of performance on diversity and inclusion matters.
• Integration of ESG into financial market decision making.
The Lloyd's ESG agenda falls into 4 main areas:

• Strategy and governance.
• Climate.
• Culture.
• Communities.
Activity
Use this link to read the Lloyd's ESG report: www.lloyds.com/about-lloyds/responsible-
business/esgreport.
What do you see happening in your own business that relates to ESG matters?
• As an insurer or a broker, do you see some risks not being renewed, for example for
coal risks?
• Do you see positive activity within the business in relation to culture or
community work?
C Overseas regulation
In this section, we will review the mechanisms by which insurers located in the London
Market can underwrite risks from overseas, and the various requirements that are imposed
in order for them to do so.
C1 Companies writing business overseas

Generally speaking, if an insurance company based in London wishes to write business in
another country it must be admitted by the regulator in that country and as a requirement of
For reference only

admittance often has to set up offices, employ staff and incur capital expenditure in the start-
Chapter 6
up of the new office.

If an insurer is authorised in one country within the EU, known as its ‘home state’, then it can
operate freely in all other EU countries – presenting a slight advantage for the EU over other
territories as a location for investment. This system is known as ‘home state financial
regulation’ and works on the basis of the regulators in each EU country respecting the
regulatory work of their colleagues in the other countries and not feeling the need to repeat
the work.
What this also means in practice is that the companies operating in the EU can make
business decisions about whether to open offices in other EU countries or just operate from
their home location, as follows:
• If they choose to open offices or establish a physical presence in another EU state, this is
known as working on an ‘establishment’ basis.
• If they choose to work only from their home state, this is known as a ‘services’ basis.
Although the EU regulators will not repeat the work of their colleagues in other countries in
respect of authorising insurers to operate in their home countries, local rules and regulations
still apply which insurers need to adhere to. These will be discussed in more detail in
chapter 7.
Brexit
The UK left the European Union (EU) on 31 January 2020, following the referendum on 23
June 2016. A transition period applied until 31 December 2020, during which the UK
continued to follow all the EU's rules.
From 11pm on 31 December 2020, UK insurers and intermediaries lost their passporting
rights to conduct business in the European Economic Area (EEA). To continue servicing
their EEA clients, many UK insurers and intermediaries decided to operate through new or
existing subsidiaries in the EEA, while the UK agreed to EEA firms continuing their
activities for a limited period of time, if they entered the UK's Temporary Permissions
Regime (TPR) at the beginning of 2020.
The EU has expressed its opposition to 'post box' European operations. And, it has
challenged arrangements where a new European operation was set up by the UK insurer
purely to deal with EU business post Brexit, with no or few employees physically present
in the relevant Member State.
Regarding the run-off period for existing insurance contracts, the UK has allowed EEA
insurers a 15-year period to continue servicing such contracts with UK insureds. The
matter is more complex for UK insurers’ contracts with EEA insureds, as every EU State
has implemented different rules which apply to UK insurers in its jurisdiction.
Negotiations about an equivalence regime between UK and EU regulation started in
March 2021 but have since broken down. It is unlikely the EU will grant equivalence to the
UK's regulatory regime, due to the expected divergence by the UK from EU rules in the
future, particularly in respect of Solvency II. Equivalence under EU law occurs where a
third party's regulatory framework is sufficiently similar to EU standards that firms from that
country are given access to the EU market. Equivalence is granted at the discretion of the
EU Commission and can be withdrawn or changed at any time. It is not, therefore, the
same as the passporting status enjoyed by UK firms before Brexit.
For reference only
Chapter 6
From the UK's perspective, the EU Solvency II regime has been criticised because of its
imposition of high-risk margin requirements. In fact, during the Queen's Speech on 10
May 2022, it was announced that the Financial Services and Markets Bill will revoke
retained EU law on financial services, replacing it with an approach to regulation that is
designed for the UK.
Please note: This is the position at the time of publication. Any relevant changes that may
affect CII syllabuses or assessments will be announced as they arise on the qualification
update page for the unit.
Activity
The benefit of being able to operate freely within the member states of the EU led Lloyd’s
to open an insurance company in Brussels which started writing business from 1 January
2019 in preparation for the UK leaving the EU. Other London Market insurers have either
opened up new offices in Europe or changed their domicile to take advantage of existing
offices in order to gain the same benefits.
Read this article about Markel opening up an EU base in Munich:
bit.ly/2k7bxRn
C1A Companies writing business in the USA

Insurance regulation in the USA is left to individual states to manage and hence insurers
from outside the USA must obtain permission multiple times to access business emanating
from across the USA. The state regulators can grant permission to foreign insurance
companies to write business alongside local insurers on what is known as an admitted
basis, but many state regulators require the submission of wordings and rates (premiums) to
be agreed.
What this means in practice is that the admitted insurers have to allow the regulators to
review all the policy wordings that they intend to use and also the premiums that are going to
be charged. This has the potential to be quite restrictive for insurers as they obviously should
not deviate from those wordings and premium rates that they have submitted. The
regulators, of course, can and will offer comments on both the wordings and the rates and
can require amendments before they can be used. Lloyd’s and in fact many insurance
companies write US business on what is known as a ‘surplus lines basis’ which removes
the need for all the filing of wordings and premium rates with the regulators.
C2 Lloyd’s writing business overseas

The Lloyd’s Market enjoys an unusual position as Lloyd’s itself undertakes to obtain
permission from international regulators – and that central permission for the Lloyd’s Market
applies to any syndicate operating within that Market. From a logistical perspective, this
provides a significant benefit to any insurer operating within the Lloyd’s Market as the
negotiations are conducted centrally on behalf of the whole Market and in most countries
(not all as we will see later in this section) the insurers do not have to set up any further
offices outside London.
The Lloyd’s Market does not have permission to write all types of business in every country
and in some countries, only reinsurance business (not direct insurance) can be written.
In June 2010, Lloyd’s was granted a licence to write direct business from China which sits
alongside the reinsurance licence it has held for a number of years.
Reinforce
In many countries, the government wants local risks written in the local insurance market
to keep premium funds within the country’s borders. In reality these risks are often too
large for the local insurers to keep themselves and so they will obtain reinsurance from the
international market (often London).
Activity
For reference only

Go to www.lloyds.com/crystal and see what activity Lloyd’s insurers are authorised to
Chapter 6
undertake in various countries around the world. Think about the risks that you might see
either as an insurer or a broker and where they come from.
Lloyd’s has representatives and offices in certain countries around the world and some
offices also have underwriters present from various syndicates to accept risks from local
brokers.
The opening of the Lloyd’s base in Singapore is a good example of how the market has
extended to the customer. The Lloyd’s physical marketplace has essentially been replicated
on a smaller scale in Singapore with a number of syndicates setting up operations in one
building – a mini ‘underwriting room’ in effect where brokers can visit a number of different
syndicates within one building.
Activity
What do you think are the benefits of having underwriters located in Singapore for both
the insurers and their clients?
C2A Lloyd’s writing business in the USA

The same provisions concerning individual state regulation apply equally to Lloyd’s as to
companies. In the USA, Lloyd’s has obtained centralised authority for the syndicates to write
business.
Lloyd’s is an admitted insurer for

direct business in only three
locations in the USA:
Kentucky Illinois US Virgin Islands
Up until 2021, Lloyd's had admitted status in Illinois, Kentucky and the US Virgin Islands.
This status meant that Lloyd’s syndicates had the same rights as local insurers in those
states. However, with those rights also came restrictions – particularly the need to file
wordings and rates (premium rates) with the regulator. This provided some inflexibility in the
way in which syndicates can deal with any business coming out of those locations.
Therefore, Lloyd's decided to relinquish those licences, meaning that no new business was
written in Illinois or Kentucky on the admitted licence after 1 July 2021 and in the USVI after
1 January 2022.
In all US locations (including the three we just highlighted), Lloyd’s has – for direct business
– what is known as surplus lines status. Insurance companies can also have this status.
What it means is that the Lloyd’s Market is a second-tier market or export market, which can
only be accessed if the local or admitted market is not able to accept the risk (or an
exemption of some type applies). The reason that the local or admitted market is not able to
accept the risk could be due to the size or complexity of the risk. However, if the placement
in the surplus lines market is challenged, the regulator will need to see that the risk was
offered to the local market first, unless the risk falls within any exemptions to the rules.
The rules for accessing the surplus lines market vary from state to state, but generally,
involve the risk having to be shown to a number of local insurers first.
Lloyd’s is fully authorised in all 50 states to accept reinsurance business with no limitations.
Question 6.2
What is the key difference between Lloyd's and company markets in relation to the
obtaining of permission to write overseas business?
a. There is no difference. □
b. Lloyd's obtains the permission centrally for all syndicates whereas companies □
have to get individual permission.
□
For reference only

c. IUA obtains permission centrally and Lloyd's syndicates have to obtain individual
Chapter 6
permission.
d. Lloyd's has to open overseas offices, however, IUA companies do not. □
C3 Satisfying overseas regulators
As a condition of granting Lloyd’s licences to write business coming out of their country, most
regulators impose a number of requirements, generally centred around reporting and the
payment of various taxes. These requirements are also imposed on any companies given
authority; however, the key difference is that Lloyd’s does the reporting centrally on behalf of
all the syndicates but each insurance company has to report to the regulators individually.
The reporting requirements vary dramatically from country to country, for example:
• Some countries are only interested in the category of risk:
– direct, facultative reinsurance, excess of loss reinsurance or proportional treaty
reinsurance.
• Some countries are interested in far more information such as:
– location of the risk;
– location of the broker;
– services or establishment business;
– tax payable (varying rates possible);
– other charges payable such as fire brigade charges; and
– the category of the risk.
The reporting is done based on premium and claims data held on central market databases
using coding which is created to permit the level of detail required by each country. Regular
reports are taken from the data and submissions made to the individual regulators. Of
course, the requirements for the data to be correct are obvious and great care has to be
taken to ensure particularly that tax information is captured correctly so that Lloyd’s can take
the correct funds from the syndicate bank accounts for onwards payment to the tax
authorities in each country, including HM Revenue and Customs (HMRC) in the UK.
C4 Insurers that are both Lloyd’s syndicates and insurance

companies
As we saw earlier, any insurer that has both a Lloyd’s syndicate and an insurance company
within its group has to consider for each risk that it reviews whether it is authorised to write
that risk – both by the local regulators and also by any overseas regulators that might have
an interest.
Many underwriters have the authority to bind risks for both platforms and can choose to take
a share for one or both entities that they represent.
Activity
Identify seven insurers working in the London Market that are both a Lloyd’s syndicate and
an insurance company.
D Lloyd’s Market governance

In this section, we will review how Lloyd’s is regulated in the UK.
The Society of Lloyd’s and managing agents are regulated by both the FCA (for conduct of
business) and PRA (for prudential requirements) whereas brokers and members agents are
regulated by the FCA for both aspects.
The regulators historically drew a distinction between the responsibilities that it placed on the
Society of Lloyd’s (Lloyd’s) and those it placed on the managing agents running the
syndicates operating within the marketplace.
The rules that apply to all other regulated insurers also apply to Lloyd’s. In essence, the
regulators wish to ensure that anyone insured within the Lloyd’s Market is at least as well-
For reference only

protected as if they had been insured by any other authorised insurer.
Chapter 6
The regulators also allow the Lloyd's Market to enjoy some flexibility in sharing out the
responsibility for controlling the various risks. Lloyd's is required to undertake the following:
• Ensure that all participants in the market are made aware of their obligations.
• Create and maintain controls over the risks to which the Lloyd’s Market is exposed and
thus impacting on funds held and managed centrally. In 2018, Lloyd’s exercised those
controls by refusing some syndicates permission in whole or in part to write the business
that they wanted to in 2019.
• Measure and assess the capital needs of each member or Name. The capital need is
measured by looking at a member’s involvement in various syndicates across the market;
it also takes into account the various types of business in which the syndicates they
support are engaged.
The managing agents are obliged to undertake the following tasks:
• File an annual solvency test return (showing that their assets constantly exceed their
liabilities to the required level).
• Assess the capital needed in order to engage in the insurance business planned for each
syndicate under their control.
• Put into place and maintain controls over risks that relate to the day-to-day insurance
business such as market risks and credit risks.
Activity
Think about the credit risks that a syndicate might run in relation to failure to pay a
premium – what steps could they take to minimise this risk?
Consider the same risk in relation to a reinsurance policy not paying claims because a
reinsurer has gone out of business – what can an insurer or a broker do to minimise
this risk?
Question 6.3
What is the key concept that underpins the regulator's willingness to allow Lloyd's a
degree of self-regulation?
a. Insureds must have the same degree of protection as if insured by a non-Lloyd's □
insurer.
b. Insureds have better terms and conditions than they would obtain from a non- □
Lloyd's insurer.
c. Insureds always obtain a formal policy document. □
d. Lloyd's must always control the risks centrally. □
D1 Lloyd’s governance structure
Various pieces of legislation impact upon Lloyd’s, the most obvious being the various
Lloyd’s Acts passed between 1871 and 1982 (and the Variation Order to the 1982 Act that
came into force in late 2008). The two key bodies in this model are the Council of Lloyd’s
and the Executive Committee.
Activity
Visit www.lloyds.com and find out more about the history of Lloyd’s including the
governance structure.
D1A Council of Lloyd’s

The Council of Lloyd’s remains the governing body of the Lloyd’s Market (or to put it more
For reference only

correctly the Society of Lloyd’s). It has the following powers:
Chapter 6
• rule-making power – can create market ‘laws’ known as byelaws;
• management and superintendence of all affairs of Lloyd’s;
• right to exercise any of the powers of the Society of Lloyd’s; and
• power to direct the insurance business at Lloyd’s.
Certain activities that only Council can undertake include:
• making or changing byelaws;
• setting the long-term strategic development of the market;
• deciding contribution levels to Lloyd’s Central Fund (covered in more detail in study
text LM2);
• deciding the amounts of members’ (Names’) annual subscriptions;
• appointing members of Council and members of the committee of the Council; and
• reviewing budgets and plans.
Members of Council
Council is made up of 15 members, who comprise working, external and nominated
members. The post of Chairman of the Council is always held by the current Chairman of
Lloyd’s.
Reinforce
Do you recall the definitions of the three types of members that make up Council? If not,
you can re-visit Market structure and features on page 5/2.
Activity
Go to www.lloyds.com/about-lloyds/governance-and-management/council-of-lloyds.
Are any of the current Members of Council linked to the organisation you work for?
The members of Council are strategic decision-makers but do not engage in the everyday
management of the work of Lloyd’s. This is done by an executive team of the Corporation of
Lloyd’s, supported by the various committees of the Council.
Activity
Find out more about the governance structure by visiting www.lloyds.com/about-lloyds/
governance-and-management.
Question 6.4
What are the three types of member that make up the Council of Lloyd's?
a. Underwriting, claims and broking. □
b. Working, outside and broking. □
c. Working, external and nominated. □
d. Operational. external and nominated. □
D2 Rules operating within Lloyd’s
As mentioned earlier, Lloyd’s is permitted to create some laws that govern the operation of
the marketplace. These laws come in two forms:
Byelaws and regulations These are known as primary rules and set out the fundamental concepts.
Requirements These are known as secondary rules; they contain the detail of what needs to
For reference only

be undertaken to comply with the primary rules. They are also structured in such
Chapter 6
a way as to allow efficient updating and amendment if required, even if the actual
byelaw remains the same.
Lloyd’s often issues additional guidance to either type of rules called Explanatory Notes;
these are not rules but should be read alongside the rules to aid interpretation. They also
issue Codes of Practice which provide operational detail as to compliance with the Rules.
Activity
Review this Code of Practice and see how it fits in with primary and secondary rules:
bit.ly/2E2ZiiK.
Not surprisingly, having made rules and set standards for the market, Lloyd’s takes any
breaches of those rules very seriously. Lloyd’s can take enforcement proceedings in relation
to any behaviour that it regards as a breach of any Rules or bringing discredit to the Market.
This is known as having enforcement jurisdiction. The FCA also has disciplinary functions
should any of its rules be breached and the two parties work together so as not to duplicate
each other’s functions in this area.
Anyone working within the Market, whether for managing agents, members’ agents or
involved through being a member is covered by the enforcement jurisdiction of Lloyd’s. The
jurisdiction covers the companies as well as the individual staff employed by them. The
penalties that Lloyd’s can impose range from fines through to lifetime bans from the market.
As guidance, Lloyd’s indicates what sort of behaviour it regards as less than acceptable.
dishonesty
any
act or
omission which is
capable of forging or faking
damaging the Lloyd’s documents
brand or to bring the
name into Examples
disrepute include:
failure to look after

failure to organise money held on trust
and/or control the (for example for a
business client)
Example 6.1
For an example of Lloyd’s issuing enforcement proceedings against individuals please
download the following document:
For reference only

https://bit.ly/3Sgj0JY
Chapter 6
Use this link to find out about Lloyd's issuing enforcement proceedings against an
organisation:
https://bit.ly/3bqakAc
Question 6.5
What are the two main types of regulation that Lloyd's issues for the Market?
a. Byelaws and requirements. □
b. Codes of practice and byelaws. □
c. Requirements and explanations. □
d. Byelaws and codes of practice. □
E Authorisation of new insurers

Any UK domiciled company wishing to transact insurance must be authorised by the UK
regulator (PRA) to do so. To gain this authorisation, the regulator must be satisfied that the
company complies with its requirements. The objective is that only companies operated by
'fit and proper' persons should be authorised to transact business. In brief, the regulator has
the power to authorise a company to transact general business and can also restrict
authorisation to specific classes of general insurance, such as accident, damage to property
or general liability.
Reinforce
Can you recall what you learned about home state regulation earlier in the chapter? If not,
re-visit Companies writing business overseas on page 6/12. Do not forget to consider the
impact of Brexit on the permission that can be given and what insurers have done so far to
be able to trade freely now the UK has left the EU.
Companies based outside the UK, but in a Member State of the EU, and wishing to transact
business in the UK also satisfy the PRA because they can no longer rely on the mutual
recognition of their home state regulation as the UK is now outside the EU.
When a UK-based insurance company decides that it wishes to transact insurance, it has to
complete and submit detailed forms to the regulator. The information given on these forms is
used by the regulator to satisfy itself that the company is financially sound, that its markets,
administration and premium structure are sound and that its key personnel are ‘fit and
proper’ persons.
For corporate newcomers to the Lloyd’s Market, three main options for participation are
available, as follows:
• Set up a new corporate member or Name to participate in syndicates that already exist.
• Set up a new corporate member or Name and a new syndicate.
• Set up a new corporate member or Name, a new syndicate and its own managing agent
to run the syndicate.
The last option is essentially the same concept as setting up a new insurance company – all
the elements are in one place.
Activity
See also the PRA’s website under ‘Authorisations’:
www.bankofengland.co.uk/prudential-regulation
This will give more information about the preparatory work that an insurer should do
before applying for authorisation.
If someone wants to set up a new business within Lloyd’s, then Lloyd’s needs to agree as
For reference only

well. In the first instance, it will want an outline briefing covering the main elements of
Chapter 6
people, plan, capital, reputation and value.

This briefing forms the basis of discussion at a meeting with a member of the Lloyd’s
relationship management team, which will cover:
• the opportunity;
• the applicant’s strategy and background;
• the structure of the proposed new business (size, structure and aims);
• classes of insurance and territories in which they want to be involved;
• underwriting and management resources;
• details of their proposed managing agent;
• sources of capital; and
• their value to Lloyd’s.
Refer to
See Example of EU regulation: Solvency II on page 7/4 for further information on
Solvency II
If Lloyd’s believes their outline proposal has the potential to meet its entry requirements it will
invite them to move to the first formal stage of the process.
Part of the initial requirements for setting up any new insurer, whether it be company or
Lloyd’s is satisfactory evidence of solvency and capital adequacy. Solvency and capital
adequacy are discussed in more detail in study text LM2, but the basic concept is ensuring
that assets always exceed liabilities.
Part of the initial requirements for setting up any new insurer, whether it be company or
Lloyd's is satisfactory evidence of solvency and capital adequacy; the basic concept here is
ensuring that assets always exceed liabilities.
Activity
Look at this website to find out more about the syndicate in a box concept which seeks to
make access to the Lloyd's market easier but without short circuiting key regulatory
requirements: www.lloyds.com/join-lloyds-market/underwriter/syndicate-in-a-box.
E1 Capital adequacy
A solvency margin is the amount by which assets must exceed liabilities. Each company
(and Lloyd's) must maintain a minimum balance between its assets and how much it knows it
has to pay or would be likely to pay in liabilities.
However, in common with other areas of regulation, the regulators historically had a risk-
based approach to insurers’ capital requirements, the detail of which is outside the scope of
this syllabus. The concept of capital adequacy, however, is that the equation also has risk
elements factored in, for example, the types of insurance written by the insurer. Certain more
volatile types of insurance require more weight on the assets side of the equation.
E2 Monitoring
Clearly, it is not sufficient for the regulator simply to establish a system for the authorisation
of applicant insurers and for determining solvency margins. They need to ensure that these
standards are maintained. Regular monitoring is, therefore, an important supervisory aspect
of the work of the regulator.
Each financial year, every authorised insurer must prepare and submit to the regulator as
part of the monitoring process the following items:
• revenue account – shows the underwriting profit or loss;
• profit and loss account – (also known as an income statement) shows the total profit
and loss made; and
For reference only
Chapter 6
• balance sheet – shows the assets and liabilities of the organisation at any given point
in time.
As we have already seen in Operation of the FCA and PRA on page 6/3, in addition to the
reports the regulator will consider each authorised firm, and analyse the degree of risk that
the firm presents. The Financial Conduct Authority uses a three pillar system involving
analysis of the risks that the business’s conduct presents.
Pillar 1 Pillar 2
Proactive Firm Supervision Event driven work
Pillar 3
Issues and products
The PRA uses a supervisory framework based on the perceived level of risk (see Table 6.1).
E3 Winding-up
Ultimately, if an insurance company fails to meet its requirements, the regulator can
intervene and the company can be wound-up (i.e. the formal cessation of the company). A
Lloyd’s syndicate can be put into ‘run-off’ (which prevents it from taking on any further
business).
The term ‘run off’ can be used for both Lloyd’s syndicates and insurance companies and the
term means that the insurer cannot write or accept any more new risks. The policies already
in force will usually be allowed to run naturally to their expected expiry. Of course, the
insurer’s liability does not finish when the policy expires as some types of policy will have
claims that take a long time to be concluded, such as liability insurances with personal injury
claims.
F The Financial Ombudsman Service (FOS)

and Financial Services Compensation
Scheme (FSCS)
In this final section, we will review the role and powers of the Financial Ombudsman
Service (FOS) and the Financial Services Compensation Scheme (FSCS). They both
play a part in the control of the insurance market although their input tends to be triggered by
claims and lessons to be learned from the way in which claims have been handled.
F1 Financial Ombudsman Service (FOS)

The FOS is a free, independent and impartial service that deals with certain disputes
between individual consumers or small businesses and financial organisations. Membership
is compulsory for all authorised firms, including intermediaries.
The FOS aims to provide both impartial and independent resolution of disputes from an
eligible complainant. An eligible complainant is a:
• consumer;
• micro-enterprise with fewer than ten employees and a turnover or balance sheet total of
no more than €2m*;
• charity with an annual income of less than £6.5m;
• trustee of a trust with a net asset value of less than £5m;
• consumer buy-to-let (CBTL) consumer;
• small business with an annual turnover of less than £6.5m and fewer than 50 employees
or a balance sheet total of less than £5m; or
• guarantor.
For reference only

Chapter 6
* (This value is in euros as ‘micro-enterprise’ is an EU-defined term.)
Activity
Discover how the FOS has handled complaints about mis-selling of payment protection
insurance at:
www.financial-ombudsman.org.uk/publications/technical_notes/ppi.html
Internal complaints procedures within the authorised firm need to be exhausted before a
complaint can be referred to the FOS. The complainant must give the insurers eight weeks
to respond before referring the matter to the FOS. The complainant then has a period of six
months from the date of the final decision from the firm to refer the matter to the FOS.
For Lloyd’s insurance, there is a Lloyd’s complaints department which is the first port of call
for a complaint about a Lloyd’s policy from an eligible complainant, before the FOS becomes
involved.
Consider this…
Why might Lloyd’s want to become involved in any complaints about Lloyd’s policies?
Review the Lloyd’s Complaints process here:
www.lloyds.com/resources-and-services/make-a-complaint/policyholder-complaint
The maximum award the FOS can require a firm to make to a complainant is now:
• £375,000 for complaints made on or after 1 April 2022 about actions or omissions by
firms that occurred on or after 1 April 2019.
• £355,000 for complaints about actions or omissions by firms on or after 1 April 2019, and
which were referred to the FOS between 1 April 2020 and 31 March 2022.
• £350,000 for complaints about actions or omissions by firms on or after 1 April 2019, and
which were referred to the FOS between 1 April 2019 and 31 March 2020.
• £170,000 for complaints made on or after 1 April 2022 about acts or omissions by firms
before 1 April 2019, but which were referred to the FOS after that date.
The FOS may recommend a higher figure, if appropriate, but this will not be binding on
the firm.
The complainant must then accept or reject the decision within the time limit specified by the
FOS. If the complainant accepts the decision it is binding on the respondent. If the
complainant rejects the decision it is not binding and they are free to pursue the matter in
court. If the complainant does not respond to the FOS’s decision letter it is treated as a
rejection and the respondent is not bound by the decision.
Question 6.6
A large chocolate manufacturer with an annual turnover of £20m has a property
insurance covering one of their factories. A claim for fire damage is declined by the
insurer and having complained unsuccessfully to the insurer the chocolate
manufacturer decides to go to the FOS. Will the FOS be able to assist them?
a. No, the FOS only assists individual insureds. □
b. No, the FOS only assists commercial insureds where the turnover is less than □
£6.5m.
c. No, the FOS only assists insureds with personal lines policies. □
d. Yes, the FOS will assist them. □
F2 Financial Services Compensation Scheme (FSCS)
The FSCS falls under the control of the FCA and provides compensation for customers of
deposit-taking companies and investment firms, as well as for those of authorised insurance
companies and intermediaries. It, therefore, covers claims against firms where they are
For reference only

unable, or likely to be unable, to pay claims against them. Usually, this is when a firm has
Chapter 6
become insolvent or has gone out of business. The scheme was set up mainly to assist
private individuals – although small businesses, charities and trusts are also covered,
broadly in line with the accessibility criteria for the FOS.
Operation of the FSCS

The FSCS reviews the company concerned and only when it is satisfied that the company
is unable or is likely to be unable to pay claims, then the FSCS declares the company to
be ‘in default’. This declaration starts the process of allowing claims to be made against
the FSCS compensation pot.
In order to protect the compensation pot, the FSCS seeks to ensure that there is
absolutely no chance of the company concerned being able to pay claims.
Insurance policyholders are protected if they are insured by authorised insurance companies
under contracts issued in the UK (and in certain cases the European Economic Area (EEA),
the Channel Islands or the Isle of Man). The scheme covers compulsory, general and life
insurance and is usually triggered if an insurance company goes out of business or into
liquidation.
The amount of compensation that a policyholder can receive depends on the type of policy
(i.e. whether it concerns compulsory insurance, non-compulsory insurance or long-term
insurance).
• Protection is 100% for:
– compulsory insurance (third party motor and employers’ liability);
– professional indemnity insurance;
– long-term insurance (e.g. pensions and life assurance); and
– certain claims for injury, sickness or infirmity of the policyholder.
• Protection is 90% of the claim with no upper limit for other types of policy, including
general insurance advice and arranging. However, there is no protection at all for
certain types of insurance such as goods in transit, marine, aviation and credit insurance.
The compensation pot is funded by a levy on all authorised firms.
On the Web
www.fscs.org.uk
F3 Lloyd’s position
Lloyd’s has a rather unusual position in that it maintains its own central pot of money as a
contingency in case the members that underwrote the risk are not in a position to pay claims.
This reserve fund is known as the Central Fund and forms part of the Lloyd’s chain of
security. This security allows Lloyd’s to state correctly that no valid insurance claim has ever
gone unpaid in its long history.
More about Lloyd’s chain of security and the Central Fund can be found in study text LM2.
For reference only

Chapter 6
Key points
Overview of the regulators in the UK
• The three regulators in the UK are the Financial Conduct Authority, the Prudential
Regulation Authority and the Financial Policy Committee of the Bank of England.
Operation of the FCA and PRA
• The FCA is responsible for consumer protection, integrity and competition.

• The PRA is responsible for promoting the safety and soundness of all its regulated
persons and for the insurance industry will have the aim of contributing to the safety
and security of those who may become policyholders.
• Society of Lloyd’s is regulated by both FCA and PRA as are managing agents.
• Brokers and Members’ agents are regulated solely by the FCA.
Overseas regulation
• Insurers wishing to write risks from overseas will also have to comply with local
regulators’ requirements, although within the EU there is flexibility resulting from each
country recognising the quality of the others’ regulators.
• For the USA the regulation is provided on an individual state basis.
• Surplus lines underwriters are not admitted in a particular country or state but act as an
additional market should the local admitted market not be able or willing to accept
the risk.
For reference only

• Lloyd’s facilitates compliance with overseas regulation centrally, but insurance
Chapter 6
companies have to engage with the regulators individually.
Lloyd’s Market governance
• The Council of Lloyd’s is responsible for the management and supervision of

the Market.
Authorisation of new insurers
• The FCA and PRA set out standards that have to be met to become authorised, and to
remain authorised to conduct business as an insurer.
The Financial Ombudsman Service (FOS) and Financial Services Compensation Scheme
(FSCS)
• The FOS exists to provide an impartial and independent final mechanism for the
handling of complaints against insurers and intermediaries. It handles complaints from
individuals, small businesses with a turnover up to £6.5m and fewer than 50
employees, and trusts with assets of up to £5m and charities with an income of less
than £6.5m.
• Lloyd’s has its own complaints department which acts in relation to complaints about
Lloyd’s policies to attempt resolution before the matter reaches the FOS.
• The FSCS exists to compensate policyholders if their insurer is unable to pay a valid
claim. They will deal only with individuals and small commercial clients generally with
the exception of employers’ liability policyholders which are eligible irrespective of size
because this insurance is compulsory.
• The amount of compensation depends on whether the insurance is compulsory,
general or long-term and also the date at which the company went into default.
Question answers
6.1 c. Making a qualifying disclosure.
6.2 b. Lloyd's obtains the permission centrally for all syndicates whereas companies
have to get individual permission.
6.3 a. Insureds must have the same degree of protection as if insured by a non-Lloyd's
insurer.
6.4 c. Working, external and nominated.
6.5 a. Byelaws and requirements.
6.6 b. No, the FOS only assists commercial insureds where the turnover is less than
£6.5m.
For reference only

Chapter 6
Self-test questions
1. Which two organisations regulate the UK insurance market?
a. The FCA and PRA. □
b. The FCA and FPC. □
c. The FPC and PRA. □
d. The FCA and Lloyd's. □
2. Which of these options is not a main objective of the FCA?
a. Consumer protection. □
b. Integrity of the financial system. □
c. Promotion of effective competition. □
d. Ensuring that insurers are profitable. □
3. Which is these is not a threshold condition that the PRA requires to be met when
becoming authorised?
a. Be appropriately staffed. □
b. Have a head office in Europe. □
For reference only
Chapter 6
c. Be capable of being effectively supervised. □
d. Conduct business prudently. □
4. Which statement best explains the concept of fair treatment of customers?
a. Always offering very low premiums. □
b. Always paying claims even if not covered. □
c. Paying due regard to the interests of the customer. □
d. Only having staff in the UK. □
5. Which of the following is an example of whistle-blowing?
a. Letting the authorities know of dangerous machinery being used in a factory □
without suitable training.
b. Asking your boss for a pay rise. □
c. Talking to the compliance team about a sanctions query. □
d. Telling the underwriting about a new claim. □
6. Briefly describe the concept of home state regulation within the EU.
a. Allowing an insurer regulated in their own country to operate freely within the rest □
of the EU.
b. Requiring an insurer to obtain separate regulatory approval in every country in the □
EU.
c. Each EU country making a separate decision whether to accept the regulation of □
the home country.
d. An insurer can only operate in its own country and is not free to work in any other □
country.
7. How do Lloyd's syndicates obtain permission to write business in other territories?

a. Each syndicate has to contact the regulators separately. □
b. Syndicates do not require any specific permission to write business in other □
territories.
c. Syndicates can either arrange their own permissions or ask Lloyd's to help them. □
d. Lloyd's obtains the permission centrally. □
8. Which of these options is not a power only held by the Council of Lloyd's?
a. Making rules such as byelaws. □
b. Management of all Lloyd's affairs. □
c. Setting the business plan for the market. □
For reference only

d. Disciplinary action. □
Chapter 6
9. Which of these categories does not describe Members of Council?

a. Working. □
b. External. □
c. Nominated. □
d. Executive. □
10. Which organisation will become involved if an insurance company is unable to pay its
claims?
a. FOS. □
b. FCA. □
c. FSCS. □
d. IUA. □
Regulatory processes,
7
systems and controls
outcomes
Introduction
A Impact of UK, EU and US regulation 8.2
B Sanctions 8.1
C Data protection 9.1
D Anti-money laundering 9.2
E Bribery 8.2
Key points
Question answers
For reference only

Self-test questions
Learning objectives
• explain the impact of US, EU and UK legislation on the way in which insurers conduct their
Chapter 7
business;
• describe the use of systems and controls to ensure that businesses adhere to the
necessary legislation;
• explain the purpose of sanctions;
• explain the principles, rights and restrictions of data protection and their impact on
transacting business;
• explain the concept of money laundering and the controls used by business to avoid its
occurrence; and
• describe the concept of bribery and the issues it presents for the insurance market.
Introduction
In this chapter, we will be exploring the various systems and controls which influence the
way business is handled and conducted in the London Market. As we have seen in earlier
chapters, only a small portion of business written in the London Market comes from UK-
based clients. Therefore, not only the UK regulators but also overseas regulators such as the
European Union (EU) have an impact on the workings of the London Market and cannot be
ignored.
Systems and controls are internal management tools that are used by businesses to ensure
that they can prove that they are in compliance with the various requirements of the
regulators. Those systems and controls do not need to be identical for every organisation if
they perform the task required of them.
We will also be looking at how and why regulators actively ban the interaction of the Market
with certain countries, entities or individuals.
Next, we will look at two areas of control: data protection and anti-money laundering. We will
focus on the impact on insurers and their customers.
Finally, we will look at the subject of bribery and the issues that it raises in the London
Market.
Key terms
Anti-money Bribery Client verification Data protection

laundering principles
Export controls Financial crime Financial sanctions Money laundering
For reference only

reporting officer
(MLRO)
Personal data Principal money Sanctions Solvency II
laundering offences
Systems and Trade sanctions
controls
Chapter 7
A Impact of UK, EU and US regulation

Now the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA)
regulate the whole UK insurance industry (i.e. not just the London Market). However, the
London Market writes considerable business from around the world and therefore is
impacted by regulation(s) imposed in other countries.
If a London Market insurer wishes to write risks coming from another country, one of the
‘prices’ that it has to pay is compliance with that country’s rules, however burdensome they
might appear to be.
Here, we will look at the systems and controls that London Market insurers must put into
place to ensure compliance with those regulations. The fine detail of the various regulations
is outside the scope of this syllabus.
A1 Obtaining information about applicable rules

The most obvious starting place for the insurer is to obtain information about any applicable
rules and regulations. There will be little sympathy from the regulators if insurers claim that
they didn’t know about the rules, so could not comply with them.
Lloyd’s has centralised departments in its Corporation focused on relations with the UK
Government and also with overseas regulators to ensure that it receives information about
the rules which can then be circulated to the syndicates. The LMA, IUA and LIIBA also send
information to their members.
Not unsurprisingly, there is a requirement from many of the regulators for regular reporting of
risks written in their jurisdiction, premiums paid, taxes applicable and claims arising. For
Chapter 7 Regulatory processes, systems and controls 7/3
Lloyd’s most of this reporting is performed centrally by Lloyd’s on behalf of the whole market,
although the managing agents still retain responsibility for ensuring that data is captured
correctly about the risks and claims.
The main aspects which impact the London Market are non-life, solvency, insurance
mediation (which mainly affects brokers), reinsurance and accounting. In practice, unless
legislation specifically indicates that it only applies to a certain country, it can be assumed
that it is applicable to the London Market.
A2 Planning
Once insurers have clarity as to what is needed, they need to plan to ensure that compliance
activities are undertaken in accordance with the requirements and on time. Again, Lloyd’s
provides some central guidance in this area to help syndicates know what must be done
and when.
Activity
Take a look at the Lloyd's website and see what actions are due in the next month:
www.lloyds.com/tools-and-systems/business-timetable
A3 Data evidence
In general terms, regulators require data evidence to show compliance with regulation, and
this is the basis of the reporting done to them on a regular basis. This data evidence may
well be accompanied by payment of monies for taxes in certain countries. In terms of
capturing the information for the reporting in the central market risk and claims databases, it
is easier to translate the various required pieces of information into codes, which are easier
to then report on.
For reference only

Consider this…
We use codes all the time without realising they are a shorthand way of seeing data. For
example, you might regularly catch the No. 42 bus in London. ‘No. 42’ is in fact a type of
code which is a far shorter name for the bus route which might have the full title of
‘Hammersmith to Liverpool St, via Aldwych, Ludgate Hill and St Paul’s Cathedral’.
Chapter 7
A good example of this principle is the coding applied to Lloyd’s premium and claims data.
This allows analysis of not only the country from which the risk has come but depending on
the country’s reporting requirements:
• location of the broker;
• location of the risk;
• any premium tax or other tax payable; and
• whether the business is direct or reinsurance.
Activity
Review any systems that you have in your office that hold data. What codes, or shorthand
data do you use, perhaps ‘USD’ for United States dollars?
Question 7.1
What information is not available through the coding applied to premium and claims
data in the London Market?
a. Account of premium being charged. □
b. Location of the risk. □
c. Premium taxes payable. □
d. Whether business is direct or reinsurance. □
A4 Example of EU regulation: Solvency II

Solvency (simply put: the balance between assets and liabilities) is vital for an insurer to be
able to continue trading. The PRA currently requires additional ‘padding’ of an insurer’s
assets, the level of which varies according to the classes of business being written. This
ensures that the extent to which assets exceed liabilities remains enough to protect the
business should a large number of claims be received.
Solvency II is the name given to the EU's Europe-wide solvency rules. When these were
introduced, the EU claimed that they:
will introduce economic risk-based solvency requirements across all EU Member
States for the first time. These new solvency requirements will be more risk-
sensitive and more sophisticated than in the past, thus enabling a better coverage
of the real risks run by any insurer.
In practice, this meant a change in the system and measures that insurers have to use to
demonstrate their solvency. It has the following aims:
• better regulation;
• deeper integration of EU insurance market;
• enhanced policyholder protection; and
• improved competitiveness of EU insurers.
Be aware
Now that the UK has left the EU, Solvency II no longer applies directly, and the concept of
equivalence comes into play. This concept basically involves trading partners such as the
EU and UK agreeing to mutually recognise that each other's standards are of equal quality
and offer the same level of protection for example to customers. As at mid-2022 the EU
For reference only

had not granted the UK financial services industry equivalence, although the UK
Government indicated in late 2020 that they would recognise the EU systems.
On the Web
Have a look at this EU website for some useful information on Solvency II:
ec.europa.eu/info/business-economy-euro/banking-and-finance/insurance-and-pensions/
Chapter 7
risk-management-and-supervision-insurance-companies-solvency-2_en
Activity
If you work for a broker, find out how your firm ensures compliance with the EU Insurance
Distribution Directive. Take the opportunity to meet your Compliance Officer.
Be aware
Although the UK has left the EU, the provisions of the IDD still apply as each individual
state was obliged to integrate them into its own national laws.
The Insurance Distribution (Regulated Activities and Miscellaneous Amendments) Order
2018 amended the Financial Services and Markets Act 2000 to implement the IDD into UK
law, and additionally the FCA made changes to its rules.
A5 Systems and controls

Systems and controls go wider than just reporting against regulatory requirements but
underpin the entire business to ensure that at no time can a risk be written by an underwriter
(or an activity be undertaken by a broker) that is in contravention of the rules.
In practice, this means putting in place the safety nets to try and avoid something happening
rather than just telling people something has happened after the event.
Reinforce
It is similar to the concept of risk management. Firms can try to avoid bad things
happening by using various mechanisms such as training staff.
But what is meant by systems and controls? Is it just setting up the computers with lots of
warning messages?
Consider this…
Look at the list of items below that form part of ‘systems and controls’. Are you surprised
by any of them? Do you think any are more powerful or useful than others?
• training and education;
• easily accessible information for staff to check;
• operating system controls, warnings and blocks;
• peer review (someone else checking your work);
• system reports to spot problems after the fact; and
• authority limits.
In fact, they are all equally valid and the most important ones are probably training and
education. Computer-based checking of processes with inbuilt blocks for certain actions is
important, but it is far more important to ensure that staff know why certain things cannot be
done, not just know that if they try to do so, that they cannot proceed.
B Sanctions
For reference only

We have said a number of times in this study text that the vast majority of the business
written in the London Market actually comes from overseas clients. International businesses
need to be aware of the existence and application of ‘sanctions’. A sanction can be quite
simply defined as a ban. Governments around the world can ban all parties (governments,
businesses, individuals) from doing business with certain individuals, businesses,
governments or even whole countries/regimes. Insurers are required to comply with these
sanctions.
Chapter 7
Consider this…
What is the point of sanctions? Why are they imposed?
Fundamentally sanctions
are imposed for the
following reasons:
political to enforce to enforce to maintain

pressure the concept the concept and restore
of respect for of respect for peace in a
democracy human rights country or
region
The following sections consider the sanctions issued by the UK Government, the EU, United
Nations (UN) and the US Government. Sanctions are imposed as a way of controlling the
access to funds for regimes, companies or persons who are felt to be less than desirable –
maybe because they have links to terrorism or other unlawful behaviour.
Activity
Review the list of reasons for sanctions above and think about news items that you might
have seen recently about countries or governments that might act in a way that will lead to
the imposition of sanctions.
Use this link as a tool to start your research:
www.bbc.co.uk/news/58888451
B1 UK/EU/UN sanctions
Remember that sanctions in their broadest definition are essentially a ban, but that ban can
take different forms. In this section, we will look at bans that are financial in nature, followed
by those bans that relate to trade.
Financial sanctions can come in a variety of forms including:
• prohibiting the transfer of funds to a sanctioned country;
• freezing the assets of a company or an individual; and
• freezing the assets of a whole government, as well as the companies and residents of the
country concerned.
The Office of Financial Sanctions Implementation (OFSI) in HM Treasury is responsible for
the implementation and administration of international financial sanctions in effect in the UK.
The OFSI has the following responsibilities inherited from the Asset Freezing Unit:
• domestic legislation on financial sanctions;
• implementation and administration of domestic financial sanctions;
• domestic designation (principally under the Terrorism Order);
For reference only

• providing advice to Treasury Ministers, based on operational advice, on domestic
designation decisions;
• implementation and administration of international financial sanctions in the UK, including
those relating to terrorism, state regimes or proliferation of Weapons of Mass
Destruction (WMD);
• working with the Foreign and Commonwealth Office on the design of individual financial
Chapter 7
sanctions regimes and listed decisions at the UN and EU;

• working with international partners to develop the international frameworks for asset
freezing; and
• licensing exemptions to financial sanctions where permitted.
The OFSI provides information on its website to alert users to sanctions imposed by the UK,
the EU and the UN.
EU regulations imposing and/or implementing sanctions are part of EU law, are directly
applicable and have direct effect in the Member States. The measures apply to nationals of
Member States and entities incorporated or constituted under the law of one of the Member
States, as well as all persons and entities doing business in the EU, including nationals of
non-EU countries. Those London Market insurers who are still writing or servicing business
in the EU, albeit via different entities should remain mindful of these sanctions.
B1A Countries impacted by UK/EU or UN sanctions
Certain countries and/or regimes have sanctions against them at any time and the list of
them is subject to change.
Activity
Visit this GOV.UK website to see the list of countries that currently have sanctions against
them. Note also the general grouping called terrorism or terrorist funding.
bit.ly/1jFLBSj
Choose any country and click on it to find out more about the specific sanctions that have
been imposed.
Remember that sanctions can be applied to individuals or companies as well as

governments or regimes.
It is possible to have sanctions lifted, and there is a list of what are known as ‘lifted regimes’
on the OFSI website as well. Those currently on the list include Libya, Haiti and Angola.
In the case of Haiti, the sanctions were imposed in 1991 after a military coup forced the
democratically elected president into exile. He managed to seize power again in 1994 and
following his return the sanctions were lifted.
Trade sanctions
As well as financial sanctions, there are also separate trade sanctions which are
managed and monitored by the Department for Business, Energy and Industrial Strategy
(BEIS).
Trade sanctions can include travel bans or bans on the import or export of certain cargoes
such as oil.
See Export controls on page 7/9 for more information about export control.
B2 US Government sanctions
The London Market has very close links with the USA, both through the business coming
into the London Market from the USA and also because many of the insurers operating in
the London Market have a US parent company.
Reinforce
Can you recall how much business comes into London from the USA and Canada? If not,
you will find the answer in the Lloyd’s and IUA links given in earlier chapters.
For reference only

Therefore, it’s very important for insurers to understand and comply with any US sanctions,
as well as those coming from the UK/EU and UN.
Although many of the countries against which the USA has sanctions are common to the
UK/EU/UN list, there are some additions as well as some variations in the extent of the
sanctions. See the special information about Cuba in Cuba on page 7/7.
Chapter 7
B2A Cuba
US sanctions on Cuba must be complied with by ‘all U.S. citizens and permanent residents
wherever they are located, all people and organizations physically in the United States, and
all branches and subsidiaries of U.S. organizations throughout the world’.
This definition would include any London Market insurer with a US parent.
The Cuban sanctions provisions are very wide-ranging and cover not just business matters
but also travel to the country. The salient part of the sanctions is that those entities subject to
the rules ‘may not provide accounting, marketing, sales, or insurance services to a Cuban
company or to a foreign company with respect to the foreign company’s Cuba-related
business’.
There is a long history between the USA and Cuba and a trade embargo has been in force
since 1960, following Cuba’s nationalisation of property belonging to US citizens. The
Helms-Burton Act 1996 restricts the conduct of business by US entities with or in Cuba and
it is a breach of this law for which insurers have to be watchful.
More information on US sanctions on Cuba can be found in the ‘Resource Center’ of the US
Department of the Treasury website (bit.ly/173sLDY). Although recently US rules in relation
to Cuba had been relaxed, the rules were tightened again in June 2019.
Example 7.1
This article illustrates the practical issues that the US sanctions has caused the cruise
industry: bit.ly/2nVNBmY
B3 Practical problems with sanctions

Historically, insurers have had to be watchful for sanctions and be careful not only to whom
they sold insurance but also to whom any claims were paid. However, in recent years
another problem has arisen whereby sanctions become part of a situation where the
offending entity is not a party to the insurance at all.
The situation is piracy, more specifically, the piracy which takes place off the coast of
Somalia. ‘Piracy’ is the act of capturing a ship and her cargo and demanding a ransom for its
return. Given the importance of a ship, her cargo and more importantly the safety and well-
being of the crew, ransoms are often paid to obtain the release.
More recently, ships have been attacked in the Gulf of Guinea and the crew taken ashore
and held for ransom, with the ship and cargo being released. While this is a different model,
the payment of ransoms is the common factor.
The organisations and individuals capturing the ships are shadowy and not necessarily all
belonging to the same group or groups; communications may be quite complex to maintain
the pirates’ cover from the authorities.
Somalia is on the sanctions list of both the UK and the USA. The UK list has several
individuals and one group to whom money should not be paid for any purpose.
However, on 13 April 2010, the USA issued an Executive Order which effectively banned any
entity with US links from making any payments specifically relating to ransoms to any of a list
of individuals and groups (called Specially Designated Nationals or SDNs) annexed to the
order, or anyone else that the US Government sees fit to include. The ban also includes
routing any money through a US bank.
Around the Gulf of Guinea the countries (Nigeria, Togo, Benin, Cameroon etc.) are not on
the sanctions list.
For reference only

This could have a major potential impact on London Market insurers as when dealing with
pirates, the identity of the direct or indirect recipients of any ransom monies might not be
entirely clear. The US order is wide-ranging and pending further clarification, the general
guidance for insurers who don’t want to risk a breach is that if there are any US involvements
anywhere insurers should consult the US Government before any payment is made to
pirates.
Chapter 7
Activity
Use this link to read the US Executive Order:
www.treasury.gov/resource-center/sanctions/Programs/pages/somalia.aspx.
B4 How do insurers find out about sanctions?

Substantial information is available on both the websites for HM Treasury and the US
Department of the Treasury, OFSI and Office of Foreign Assets Control (OFAC).
Lloyd’s insurers and brokers can also access the Crystal system on the Lloyd’s website
which has information about sanctions on a country by country basis.
The Market Associations also provide guidance to their members.
Activity
Visit the Office of Foreign Assets Control (OFAC) website to find out more about US
sanctions:
www.ustreas.gov/ofac
Activity
Consider what impact Russian sanctions has had on your organisation. Try and speak to
colleagues such as the compliance team to find out some of the challenges in keeping up
with the constant changes to sanctions requirements.
Question 7.2
Against which combination of parties can sanctions be imposed?
a. Individuals and companies. □
b. Companies and governments. □
c. Governments, individuals and companies. □
d. Governments and individuals. □
B5 Sanctions clauses
London Market insurers and reinsurers will insert sanctions clauses into their policies to
make clear what their position will be. An example of one of these is shown below:
Sanction Limitation and Exclusion Clause
No (re)insurer shall be deemed to provide cover and no (re)insurer shall be liable
to pay any claim or provide any benefit hereunder to the extent that the provision
of such cover, payment of such claim or provision of such benefit would expose
that (re)insurer to any sanction, prohibition or restriction under United Nations
resolutions or the trade or economic sanctions, laws or regulations of the
European Union, United Kingdom or United States of America.
JC2010/014
B6 Export controls
The UK Government issued an Export Control Order in 2008 (updated several times since
For reference only

with more items which fall into the categories below). This order updated previously existing
legislation and requires that a licence is obtained:
• If there is movement of arms or other military goods between two overseas countries (i.e.
not the UK).
• If there is the involvement of any UK person including those UK entities which might be
involved only by insuring such goods.
Chapter 7
There are various categories of licence, as shown in Table 7.1:
Table 7.1: Categories of licence (export controls)

Category Includes
Category A Gallows, guillotines and electric chairs.
Category B Rocket launchers, other similar missile launchers being capable of operation by three people
or less, unmanned aerial vehicles and hand grenades.
Category C Military goods which do not otherwise fall into Category A or B, tear gas equipment, pepper
spray and PAVA spray which operates in the same way as CS Gas by causing pain and
disabling people if sprayed into the eyes.
Category A goods require insurers to obtain a licence from the UK Government if they are
being insured, but Categories B and C only require a licence if the insurance is being
obtained for a journey to an embargoed country. This is not an area where late reporting and
an apology will be acceptable. Trading (and that includes providing insurance) without a
licence is a criminal offence and will result in fines and even imprisonment.
An embargo is a trade ban, and as we have previously seen earlier in this chapter there are
some countries to which trade is prohibited.
The list of embargoed countries under the ECO 2008 contains countries such as Burma, Iran
and China.
Activity
Visit the GOV.UK website to find out more about export control:
www.gov.uk/government/organisations/export-control-organisation
Read these specific ECOs relating to North Korea and Venezuela issued in 2018:
www.legislation.gov.uk/uksi/2018/200/contents/made
www.legislation.gov.uk/uksi/2018/108/contents/made
C Data protection
C1 UK Data Protection Regulation (UK GDPR)
Who does the UK GDPR apply to?
The UK GDPR applies to data controllers and processors in the United Kingdom, including
Northern Ireland. Prior to its introduction, the European Union (EU) GDPREU General Data
Protection Regulation (EU GDPR) applied.
The UK GDPR places legal obligations on processors. For instance, firms are required to
maintain records of personal data and processing activities, and a firm has significant legal
liability if it is responsible for a breach.
Controllers are not relieved of their obligations where a processor is involved. The UK GDPR
places obligations on controllers to ensure their contracts with processors comply with the
regulations.
What information does the UK GDPR apply to?
It applies to personal data of an identified living individual. However, the definition of
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personal data reflects changes in technology and in the way in which information is
collected. It makes it clear that information such as an online identifier – e.g. an IP address –
can be personal data.
It also applies to both automated personal data and to manual filing systems where personal
data is accessible according to specific criteria. This is similar to the EU GDPR but wider
than the definitions in the previous UK data protection legislation. It could include
chronologically ordered sets of manual records containing personal data. Personal data that
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has been anonymised – e.g. key-coded – can fall within the scope of the UK GDPR
depending on how difficult it is to attribute such data to a particular individual.
Sensitive personal data
The UK GDPR refers to sensitive personal data as 'special categories of personal data'.
These categories include:
• race;
• ethnic origin;
• politics;
• religion;
• trade union membership;
• genetics;
• biometrics (where used for ID purposes);
• health;
• sex life; or
• sexual orientation.
Principles
Under the UK GDPR, the data protection principles set out the main responsibilities for
organisations. The most significant addition is an emphasis on accountability. The UK GDPR
requires firms to show how they comply with the principles – for example, by documenting
the decisions they take about a processing activity.
Consider this…
Data Protection Principles under the UK GDPR
The following principles apply to all personal data:
1. Lawfulness, fairness and transparency: data should be processed lawfully; data should
be handled in ways people would expect giving consideration to the effect of
processing the data on the individuals concerned; and there should be full compliance
with the obligations of the 'right to be informed'.
2. Purpose limitation: data should only be collected for specified, explicit and legitimate
purposes and not further processed in a manner that is incompatible with those
purposes.
3. Data minimisation: data should be adequate, relevant and limited to what is necessary
in relation to the purposes for which it is processed.
4. Accuracy: data should be accurate and, where necessary, kept up to date.
5. Storage limitation: kept in a form which permits identification of data subjects for no
longer than is necessary for the purposes for which the personal data is processed.
6. Integrity and confidentiality: data should be processed in a manner that ensures
appropriate security of the personal data, including protection against unauthorised or
unlawful processing and against accidental loss, destruction or damage, using
appropriate technical or organisational measures.
Lawful processing
For processing to be lawful under the UK GDPR, firms need to identify a lawful basis before
they can process personal data and document it. This is significant because this lawful basis
has an effect on an individual's rights. The six lawful bases for processing data are:
1. Consent
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Consent must be a freely given, specific, informed, and unambiguous indication of the
individual's wishes. There must be some form of positive opt-in; consent cannot be
inferred from silence, pre-ticked boxes or inactivity, and firms need to make it simple for
people to withdraw consent. Consent must also be separate from other terms and
conditions and be verifiable. Where a firm relies on someone's consent, the individual
generally has stronger rights, for example to have their data deleted.
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2. Contract
The processing is necessary for a contract a firm has with the individual, or because they
have asked the firm to take specific steps before entering a contract.
3. Legal obligation
The processing is necessary for a firm to comply with the law (not including contractual
obligations).
4. Vital interests
The processing is necessary to protect an individual's life.
5. Public task
The processing is necessary for a firm to perform a task in the public interest or for its
official functions, and the task or function has a clear basis in law.
6. Legitimate interests
The processing is necessary for a firm's legitimate interests or the legitimate interests of a
third party, unless there is a good reason to protect the individual's personal data which
overrides those legitimate interests.
Rights
The UK GDPR contains similar rights to the EU GDPR, creates some new rights for
individuals and strengthens some of those that existed under previous data protection
legislation.
Right to be informed • Individuals have the right to be informed about the collection and use of
their personal data.
• This must be provided to individuals at the time the personal data is
collected from them.
Right of access • Individuals have the right to find out if an organisation is using or storing
their personal data.
• They can exercise this right by submitting a subject access request
(SAR) to the organisation concerned.
• A company should respond to an SAR within one month; it can take an
additional two months in certain circumstances.
Right to rectification • Individuals have the right to have inaccurate personal data rectified or
completed if it is incomplete.
• An individual can make a request for rectification verbally or in writing.
Right to erasure • Individuals have the right to have their personal data erased, also known as
'the right to be forgotten'.
• The right is not absolute and only applies in certain circumstances.
Right to restrict processing • Individuals have the right to request the restriction or suppression of their
personal data.
• This is not an absolute right and only applies in certain circumstances.
• When processing is restricted, an organisation is permitted to store the
personal data, but not use it.
Right to data portability • This allows individuals to obtain and reuse their personal data for their own
purposes across different services.
Right to object • This gives individuals the right to object to the processing of their personal
data in certain circumstances.
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• Individuals have an absolute right to stop their data being used for direct
marketing.
Rights in relation to • An individual has the right not to be subject to a decision based solely on
automated decision making automated processing.
and profiling
• Processing is 'automated' where it is carried out without human intervention
and where it produces legal effects or significantly affects the individual.
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Accountability and governance

Accountability is one of the data protection principles under the UK GDPR. Firms are
expected to put into place comprehensive but proportionate governance measures. Good
practice tools such as privacy impact assessments and privacy by design are now legally
required in certain circumstances. Practically, this is likely to mean more policies and
procedures for organisations, although many will already have good governance measures
in place.
Breach notification
The UK GDPR introduces a duty on all organisations to report certain types of data breach to
the ICO, and in some cases to the individuals affected.
Transfers of personal data to third countries or international organisations
To ensure that the level of protection of individuals afforded by the UK GDPR is not
undermined, restrictions have been imposed on the transfer of personal data outside the EU,
to third countries or international organisations.
The UK GDPR still applies directly to firms operating in the EEA post-Brexit, and to any
organisations in Europe that send data to firms in the UK. These UK transfer rules broadly
mirror the EU GDPR rules, but the UK has the independence to keep the framework
under review.
C2 Data Protection Act 2018 (DPA 2018)

The DPA 2018 came into effect in the UK in May 2018, to coincide with the implementation
of the EU GDPR. Since Brexit, the key principles, rights and obligations remain the same.
However, there are implications for the rules on transfers of personal data between the UK
and EEA countries.
Be aware
DPA 2018 has been amended to reflect the UK GDPR and remains the legislation
governing data protection in the UK.
Main elements of the DPA 2018:

• Ensuring that sensitive health, social care and education data can continue to be
processed, to ensure confidentiality in health and safeguarding situations.
• Restricting the rights to access and delete data where there are legitimate grounds for
doing so (e.g. for national security purposes).
• Setting the age from which parental consent is not needed to process data online.
• Providing the ICO with enhanced powers to regulate and enforce data protection laws.
– For the most serious data breaches, it can levy fines of up to £17.5 million or 4% of
annual global turnover.
– The ICO can bring criminal proceedings against a data controller or processor if they
have altered records following an SAR with the intent to prevent disclosure.
C3 What does this mean for organisations?

Any firm that handles data and/or engages in any form of marketing to the public needs to
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prepare itself to comply.
Non-compliance will result in significant costs not just in reputational damage. Fines by the
Information Commissioner’s Office could go upwards of £17,500,000 or 4% of global
revenue, whichever is highest. Over 60 fines have been issued to date, including Cathay
Pacific and Dixons being fined GBP 500,000 each although their breaches were before the
GDPR regulations came into force. There have been ICO proposals of fines of over GBP
180,000,000 being imposed on British Airways, and GBP 99,000,000 on Marriott for data
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breaches. These investigations are still ongoing.
As though this is not enough, the FCA has said that ICO penalties could also give rise to
their own investigations on Systems & Controls. Finally, there is an updated right for data
subjects to claim compensation for damages they suffer from such incidents.
C4 What should firms have done so far?

The urgent priority for businesses is to identify exactly what data they hold, how and where
this information is stored.
This will apply both to existing data storage, which may be spread across several systems,
held in different formats and often poorly reconciled, and new data as it comes into the
organisation.
A key part of this process will be understanding what permissions have been obtained for
each element of data held. Where those consents are lacking or insufficiently explicit under
the UK GDPR, it may be necessary to contact customers in order to obtain the right
permissions.
Firms should also think of how data is used across the business. Under the UK GDPR, firms
will have to consider every use for their data (both current and in development) in order to
establish what remains viable, and what needs to change.
This process must take place in every function, such as:
Claims Insurers are already using data and analytics tools for fraud prevention, and firms are
considering the use of social media to provide evidence of fraudulent claims, but the
new regulation on the consent required for data processing may pose a threat to
this work.
Pricing While telematics helps insurers price policies on a much more bespoke basis, the UK
GDPR will limit how telematics data can be used without consent.
Underwriting Data enables insurers to identify smaller and smaller homogeneous pools of risk,
particularly by bringing in non-traditional insurance data such as customers’ credit
histories and health records – and even data from geo-location tools.
Question 7.3
Which statement about the UK GDPR is correct?
a. It enhances previous UK data protection legislation. □
b. It bridged a gap until the UK left the EU. □
c. It replaces previous UK data protection legislation. □
d. It means insurers cannot keep mailing lists. □
D Anti-money laundering
We will now look at the process by which funds which have been obtained illegally are made
to look legitimate by ‘laundering’ through a financial system (which is not always insurance-
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based). In this case ‘laundering’ has nothing to do with washing but the analogy of making
something clean is relevant to the process and end result.
D1 Definition
Money laundering is the process by which criminals (including terrorists) attempt to disguise
the origin of cash or other assets that they have earned from crime. They do this to avoid
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having the money or assets seized by the authorities and to keep them distanced from the
original crime that generated the money. This does not apply only to large criminal
syndicates but may be on a much smaller scale.
Money laundering has a particular relevance in the financial services sector. A criminal may
choose to deposit their illegally obtained cash into an apparently legitimate arrangement,
such as a pension, life policy, unit trust, building society account or into travellers’ cheques.
They may take out a general insurance policy and then cancel it shortly after so they can get
the return premium. Criminals are happy to discount money (i.e. lose a small percentage as
a penalty) if the result of the transaction is that it becomes ‘clean’ money.
The traditional model used to describe money laundering comprises a three-stage process,
as follows:
Placement This is the process of putting cash into the financial system and converting it into
other financial assets, such as cheques or even property.
Layering It may still be possible to trace the money back to its illegal origins so the criminal will
want to get involved in layering. Layering is where the criminal creates a series of
complex transactions.
Integration This is where the criminal finally gets access to the ‘clean’ money. There are many
ways of giving the impression of a legitimate arrangement. The replacement of stock
and its sale to the public is one example. Often much more sophisticated methods
are used. Buying or leasing property or creating a company and drawing a salary are
two more examples.
The three stages may occur as separate and distinct phases or they may overlap and it is
unlikely that all three would occur at the same financial institution.
Question 7.4
What are the three distinct phases of the traditional money laundering model?
a. Placement, layering and flushing. □
b. Placement, layering and integration. □
c. Layering, integration and transacting. □
d. Placement, integration and loading. □
D2 Sources of law and regulation concerning money
laundering
There are three strands to the rules that apply to money laundering:
• Specific laws that define what represents a criminal offence and the penalties that apply
to such Acts (which are of general application).
• Money laundering regulations that apply to a stated range of firms operating in the
financial services sector (but not necessarily specific to general insurance).
• FCA rules and guidance that apply in different ways to different categories of
regulated firms.
D3 Money laundering legislation

The UK law relating to money laundering has developed and widened over time as follows:
Consider this…
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Do you think that the international nature of the London Market makes it more, or less,
difficult to spot money laundering issues?
Criminal Justice Act 1988 created the criminal offence of money laundering, but only in respect of drug
trafficking and terrorism.
Criminal Justice Act 1993 made it a criminal offence to launder the proceeds of other serious crimes.
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Proceeds of Crime Act 2002 extended the range of offences for money laundering.
(POCA)
POCA established the current principal money laundering offences:

• concealing, transferring, converting, or removing criminal property. ‘Concealing’
would include hiding cash or valuables; ‘transferring’ would include sending a BACS
transfer; ‘converting’ includes selling a stolen car for cash;
• making arrangements in respect of criminal property. This has a very wide definition
and would, for example, include organising the sale of criminal property or setting up an
account to receive the proceeds of crime; and
• acquiring, using or possessing criminal property. ‘Acquiring’ would include
purchasing criminal property. ‘Using’ would include presenting criminal property as
collateral for a loan. ‘Possession’ would include a bank holding the proceeds of crime in a
client’s bank account.
In addition, it established:
• offences of failing to report suspected money laundering; and
• offences of tipping off about a money laundering disclosure (a suspicious report) or
investigation.
The ‘principal money laundering offences’ apply to everyone; the others apply only to
persons who carry out regulated activity in the ‘regulated sector’, whether or not the specific
FCA money laundering rules (see below) apply to those firms.
An offence is committed if a person does the act described and at the same time has a guilty
state of mind (i.e. if they know or suspect that the relevant acts involve criminal property).
Sanctions
The sanction is the same for each principal offence: a maximum prison sentence of 14
years, an unlimited fine, or both. The sanction for the other two types of offence (failing to
report suspected money laundering and of tipping off about a money laundering disclosure
or investigation) is a maximum prison sentence of five years, an unlimited fine, or both.
The offence of ‘failing to report’ is subject to an objective test of negligence, in other words a
test of reasonableness.
Question 7.5
Imagine you are a claims handler. You are concerned about the fact that the claim
funds appear to be being paid to an entity that is unconnected with the policy and is
not otherwise involved in the claim.
If you ignore your suspicions and pay the funds, of which offence (aside from any
principal money laundering offence), if any, might you be guilty under POCA?
a. Integration. □
b. Tipping off. □
c. None. □
d. Failing to report. □
The Serious Crime Act 2007 (SCA) extended a range of serious crime prevention orders
that could be made by the High Court and amended POCA in a number of important
respects. It created the National Crime Agency whose financial investigators are charged
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with recovering the proceeds of criminal activity.
D4 Money Laundering Regulations

The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the
Payer) Regulations 2017 are fundamental to money laundering prevention in the finance
sector. They require the creation and maintenance of systems to prevent and control money
laundering and effective training to be in place. The provisions apply to defined organisations
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operating in the UK financial sector, but not general insurance activities, including mediation
activities.
The regulations apply to 'relevant persons', including:
• credit and financial institutions (which includes insurers and brokers);
• auditors, insolvency practitioners, accountants and tax advisers;
• lawyers;
• trust or company service providers;
• estate agents;
• high value dealers (any business or sole trader that accepts or makes high value cash
payments of €10,000 or more for goods); and
• casinos.
The ‘relevant persons’ listed in the regulations must:
• conduct a money laundering and terrorist risk financing risk assessment;
• implement systems, policies and procedures to address the risk and meet the
requirements under the regulations;
• apply those policies and procedures across the entire business;
• adopt internal controls;
• train staff;
• comply with new customer due diligence; and
• ensure record keeping and data protection systems, policies and procedures comply with
the regulations.
D5 Regulatory rules and guidance on financial crime

The Financial Conduct Authority gives high priority to the protection of consumers as
potential victims of financial crime, as well as the use of firms as the conduit for
financial crime.
Activity
Given what you have just learned about anti-money laundering, think about practical steps
that companies can take to prevent possible problems. Think about education, procedures
and systems solutions.
‘Financial crime’ was defined in the Financial Services and Markets Act 2000 (FSMA) as
fraud, dishonesty, misconduct in, or misuse of information relating to, a financial market,
handling the proceeds of crime or financing terrorism. The FCA concentrates on identifying
current and emerging financial crime threats and on ensuring that the awareness of their
implications and how to mitigate them is embedded across the operations. The aim is that
firms maintain and where necessary enhance their own systems and controls against
financial crime. The FCA is using thematic reviews involving detailed testing as to whether
firms are meeting their legal and regulatory obligations.
The FCA can impose penalties for market abuse and undertake criminal prosecutions for
insider dealing and market manipulation.
Joint Money Laundering Steering Group (JMLSG)

The JMLSG is made up of the leading UK Trade Associations in the financial services
industry. Its aim is to promote good practice in countering money laundering and to give
practical assistance in interpreting the UK Money Laundering Regulations. This is
primarily achieved through the publication of industry guidance which is then used by the
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FCA in consideration of whether breaches have happened within the financial services
industry.
This group includes organisations such as the Association of British Insurers, the British
Bankers Association and the Council of Mortgage Lenders.
Many insurers and brokers will have considered these standards in order to establish their
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own procedures in support of their general duty to meet regulatory requirements.
Regulatory rules insist that firms must have in place systems and controls, which must
include giving their employees suitable training, with regard to money laundering. The
governing body and senior management must be in receipt of certain information and the
firm’s appointed Money Laundering Reporting Officer (MLRO) must make a report at least
annually on how the systems and controls operate and on their effectiveness.
Activity
Look at the JMLSG website and find out more about its role and the guidance it issues to
the market:
www.jmlsg.org.uk
The firm also needs to document both its risk profile and risk management policies in relation
to money laundering. On a day-to-day basis it must take the risk of money laundering into
account when developing new products, taking on new customers and when changing its
business profile.
The nominated officer (either a director or senior manager) who may also be the MLRO
must take overall responsibility for establishing and maintaining effective anti-money
laundering systems and controls within the firm.
The role of the nominated officer is someone who is ‘nominated’ to receive disclosures under
the Terrorism Act 2000 or Part 7 (the money laundering section) of the Proceeds of Crime
Act 2002. An MLRO is someone appointed under the FCA rules to act as the focal point for
all activity within the firm relating to money laundering. There is a high degree of cross over
within the roles, hence they are often performed by the same person.
Note the following about the MLRO:

• Takes responsibility for the firm’s compliance with the FCA rules relating to money
laundering.
• Acts as focal point for all anti-money laundering activity in the firm.
• Expected to be UK-based.
• Required to have certain levels of authority and independence within the firm.
• Required to have sufficient resources and information to enable them to fulfil their
responsibilities.
Anyone who suspects that money laundering is taking place must report this to the
nominated officer/MLRO. The nominated officer must then decide whether the suspicious
transaction should be reported to the National Crime Agency (NCA). As you saw earlier,
failure to report knowledge or a suspicion of money laundering is a criminal offence.
Reporting to your nominated officer/MLRO discharges your legal responsibilities.
D6 Protection measures
To aid the detection of money laundering it is important to protect the person who reports
their suspicions. The NCA must know their identity as they may need to obtain further
information from them in pursuing their investigations. Outside the investigation, however,
their names will be concealed and they will not be called upon to give evidence.
Reinforce
Do you remember how whistle-blowers are protected? If not, revisit Public Interest
Disclosure Act 1998 (PIDA) on page 6/10.
D7 Client verification
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Firms must take all practical measures to check the identity of new clients. This includes
ensuring that their address details are genuine. Money laundering regulations are not
specific as to the precise nature of appropriate means of identification. However, guidelines
issued by JMLSG state that client verification for individuals should be ‘photographic’. They
will be among the following:
• A valid passport.
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• Valid photo card driving licence.

• National identity card for non-UK nationals.
• Firearms or shotgun certificate.
• Identity card issued in Northern Ireland.
A home visit to the client is suitable evidence, provided that it is clear that the house
genuinely is the personal residence of the client and this is only one of two means of
identification.
A client’s bank or another reputable financial institution can be asked to verify their identity
where they are not being met face-to-face.
Identification requirements for a company
In the case of a company, it is necessary to establish:
• its full name;
• registered number;
• registered office in the country of incorporation; and
• business address and to check that it legally exists for normal business operations. This
could be done by, for example, obtaining a copy of its Certification of Incorporation or
searching the relevant company registry. Any complex ownership arrangements should
be clarified.
Proof of identity should be obtained as soon as possible and transactions should not be
completed until it has been provided. Any verification difficulties should usually be reported
to the MLRO and, possibly, by the MLRO to the authorities.
Records must be kept for five years.
Activity
Think about how this works in a commercial insurance situation which includes an insurer,
broker and client. Does the insurer have to confirm all the details independently or can it
rely on the broker verifying their client’s identity?
Ask your colleagues what they think. Try to find out what happens in your company.
D8 Summary of money laundering rules

General insurers and intermediaries are subject to the regulators’ high-level rules, which
contain specific requirements regarding anti-money laundering measures. Their employees
are also individually subject to the terms of CJA and POCA.
Therefore, although general insurers and intermediaries are not directly impacted by the
Money Laundering Regulations, they are required to comply with the regulators’ specific
money laundering rules. Firms must follow guidance issued by the JMLSG in relation to
client verification, and appropriate systems and controls.
E Bribery
In this final section we are going to consider an area which has become very much in focus
in recent years.
Another word which should be used for ‘bribery’ is ‘corruption’, particularly if public officials
are involved, which gives an indication of the seriousness with which this issue should be
treated.
The Bribery Act 2010 covers four major offences, which are:
• bribing another person;
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• receiving a bribe;
• bribing a foreign public official; and
• the corporate offence of failing to prevent bribery.
The first two were not new offences but the Bribery Act 2010 harmonised pre-existing
legislation on the topic; however, the last two offences were new.
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The last offence listed is a corporate offence and companies are at risk if they do not put in
place systems and controls to counter this risk. Suggested systems and controls include:
• There should be an anti-corruption culture in the organisation, led by its directors.
• There should be a named senior individual responsible for anti-corruption procedures in
the organisation.
• Risk assessments should be in place to determine the potential risk of bribery occurring.
• Organisations should have a clear code of conduct that addresses anti-corruption issues.
• Penalties for participating in corrupt activities should be clearly spelt out in employees’
contracts of employment.
• Organisations should have a procedure relating to gifts and hospitality that sets out what
is and what is not acceptable and ensures that corruption does not occur.
• Employees should be given training in anti-corruption matters.
• Such financial controls should be in place that the possibility of corruption is made
unlikely.
• Such whistle-blowing procedures should be in place that employees could report any
matters relating to corruption without fear of retaliation.
Given that a number of London Market brokers have received fines for a bribery offences,
this is obviously something that all market participants need to be very mindful of, and in
certain cases money laundering and bribery issues will arise with the same activities.
Activity
Review the FCA reports on the fines mentioned above:
bit.ly/2oPy2wT
bit.ly/2oJzkcT
bit.ly/2o42fZ6
bit.ly/3JxiL9y
There is also US legislation (Foreign and Corrupt Practices Act 1977) which prohibits
bribery of foreign government or political officials. Given that some London Market insurers
and intermediaries have ties with US entities, it is important for them to be mindful of this US
legislation in the same way as they must be mindful of the relevant US sanctions.
Activity
Speak to your firm’s Compliance Officer and ask them what actions they are taking to
ensure compliance with this legislation. Have you had any specific training on the subject?
Review the Ministry of Justice guidance on the Bribery Act to see if corporate hospitality is
impacted:
www.justice.gov.uk/downloads/legislation/bribery-act-2010-guidance.pdf
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Key points
Impact of UK, EU and US regulation
• A significant amount of London Market business comes from outside the UK.
Sanctions
• The UK Government together with the European Union and the United Nations
imposes bans on dealing with certain governments, regimes, individuals and
organisations called sanctions.
• The US Government also imposes sanctions which impact on insurers operating in the
London Market, particularly if they have US corporate parentage.
Data protection
• Data protection is an important area of business and there are clear rules to ensure the
safety and accuracy of any personal data held by companies.
• The DPA 2018 and the EU GDPR came into force in May 2018 and replaced pre-
existing data protection legislation.
• The UK GDPR came into force in Jan 2021 and replaces the EU GDPR.
Anti-money laundering
• Money laundering is converting illegal funds into legal funds through transactions.
Payment of premium using illegal funds and then requesting a return premium is a
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good example of such activity.
Bribery
• Bribery includes bribing others, being bribed, bribing a foreign public official and failing
to prevent bribery.
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Question answers
7.1 a. Account of premium being charged.
7.2 c. Governments, individuals and companies.
7.3 c. It replaces previous UK data protection legislation.
7.4 b. Placement, layering and integration.
7.5 d. Failing to report.
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Chapter 7
Self-test questions
1. Which of these different types of information about a risk would an overseas
regulator not be interested in?
a. Location of the risk. □
b. Amount of gross premium paid. □
c. Location olf the broker. □
d. Whether the risk is direct or reinsurance. □
2. Identify something which is not an example of systems and controls within a
business?
a. Authority limits. □
b. Training. □
c. Computer controls. □
d. Salary limits. □
3. What are the two main types of sanction that affect insurers?
a. Financial and sporting. □
□
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b. Financial and trade.
c. Trade and sporting. □

d. Economic and political. □
4. What is OFAC?
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a. The part of the US Government that issues sanctions related guidance. □
b. The part of the UK Government that issues sanctions related guidance. □
c. The part of the EU that issues sanctions related guidance. □
d. The part of the UN that issues sanctions related guidance. □
5. Why are Cuban risks of interest to London Market insurers?
a. They are generally quite profitable. □
b. Insurers with US parents need to be aware of US sanctions. □
c. There are substantial additional taxes to be paid. □
d. Insurers with UK parents need to be aware of UK sanctions. □
6. Under the Money Laundering, Terrorist Financing and Transfer of Funds (Information
on the Payer) Regulations 2017, what additional risk assessment needs to be done,
alongside the risk of money laundering?
a. Bribery. □
b. Sanctions. □
c. Terrorist financing. □
d. Fraud. □
7. What is the key requirement in order to hold personal data under GDPR?
a. Using it regularly. □
b. Only using it once. □
c. Only storing it electronically. □
d. Permission from the person concerned. □
8. What are the three stages in money laundering?
a. Placement, layering and integration. □
b. Placement, hiding and integration. □
c. Finding, layering and integration. □
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d. Placement, layering and reusing. □
9. What behaviour during a claim might make you suspect money laundering?
a. Request for payment by cheque. □
□
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b. Request to pay claims proceeds to someone not previously involved.
c. The insured being cooperative. □

d. More than one claim in a single policy year. □
10. What are the offences under the Bribery Act 2010?
a. Taking a bribe, bribing others. □
b. Bribing a public official overseas and failing to prevent bribery. □
c. Taking a bribe, failing to prevent bribery. □
d. Taking a bribe, bribing others, bribing a public official overseas and failing to □
prevent bribery.
Role of a broker
8
outcomes
Introduction
A Legal basis of the broker’s role 10.1
B Regulation 7.6
C Services provided by intermediaries 10.2
D Broker’s role in the placing process 6.4, 10.2, 10.3
E Broker’s role in the claims process 6.4, 10.4
Key points
Question answers
Self-test questions
For reference only

Learning objectives
• explain the role and responsibilities of brokers/intermediaries;
• explain how intermediaries are authorised and supervised;
• explain the business role of broking and the parties involved; and
• explain the broker’s role in the placing and claims processes.
Chapter 8
Introduction
In this chapter we will be reviewing the role and importance of intermediaries – better known
as brokers – in the insurance process and in the London Market. We will be exploring their
relationship in law with both the insurers and the insured – and their responsibilities coming
out of those relationships. We will also look at where they fit in the market processes for both
placing and claims.
Key terms
Actual authority Agency by consent Agency by necessity Agency by

ratification
Agent Appointed Authorised persons Binding the risk
representatives
Broker Insurance Delegated authority Law of agency Principal
Document (BID)
Retail broker Termination of Terms of business Wholesale broker
agency agreement (TOBA)
A Legal basis of the broker’s role

In this section we will look in more detail at the role of a broker, and for whom they perform
this role. We will draw some distinctions with other types of intermediaries that may become
involved in different classes of business.
For reference only

A1 Who are the parties in the insurance transaction?
The most straightforward insurance transaction involves just two parties: the buyer of
insurance (or the insured) and the seller of the insurance (the insurer).
However, the buyer of insurance may not be knowledgeable about the options available to
them either in terms of product or market and so will seek help from an expert adviser. This
adviser is a broker, who is able to offer independent impartial advice concerning available
products and markets and can represent the insured in communications and negotiations
with any potential insurers.
A2 Principal and agent

In legal terms an ‘agent’ is one who is authorised by one party – termed the ‘principal’ – to
Chapter 8
bring that principal into a contractual relationship with another – termed the ‘third party’.
Here, the client is the principal, the broker is the agent and the insurer is the third party.
Figure 8.1 depicts the relationships described:
Figure 8.1: Relationship between the principal, agent and third party
Contract is between insurer and client only
Client Insurer
Broker
Data flows from client to insurer through broker
There are other types of intermediaries who act as agents for insurers in that they are only
permitted to promote and provide certain insurer products to their customers. These types of
intermediaries are not generally encountered in the commercial business handled in the
London Market but are heavily involved in more personal lines products such as household,
Chapter 8 Role of a broker 8/3
motor and pet insurance. They will be covered in more detail in study text LM2: London
Market insurance principles and practices.
Activity
Talk to your friends or colleagues about their personal insurances (e.g. home, car or
travel). Did any of them use a broker, and if they did, can they explain why?
Record their reasons and consider them as you review the rest of this chapter.
A3 Law of agency
In law, everyone who acts on behalf of another person is an agent. If we allow someone to
act for us, or even if we allow them to say that they are acting for us without denying the fact,
we will probably have to accept responsibility for whatever actions they undertake on our
behalf.
A3A Methods of creating an agent/principal relationship
There are three ways in which the relationship
of principal and agent can arise.
This may be by:
consent necessity ratification
Agency by consent
The most usual way of creating a relationship between principal and agent is by consent,
also known as an agency by agreement. Both parties enter into a legally enforceable
For reference only

agreement. This is usually by means of express appointment where the terms of the
appointment are written down. It is by far the most common method used in insurance. The
documents used in the London Market are called terms of business agreements (TOBAs).
These are put in place between any brokers and their clients as well as (perhaps
unexpectedly) between brokers and the insurers with which they are placing business.
TOBAs are studied in more detail in study text LM2 but it is important to understand that their
key role is to set out clearly each party’s rights and responsibilities regarding the relationship
into which they have entered.
It is also possible for an agency relationship to be created by consent in an implied way.
This could be the case where work is undertaken and a commission paid but no agreement
is written down.
Agency by necessity
Chapter 8
This arises where a person is entrusted with someone else’s goods and it becomes
necessary to act in a certain way in order to preserve the property in an emergency.
Example 8.1
An example of this would be where you were looking after your friend’s furniture for a
short time whilst they were moving house.
You suffered an accidental fire in the building where the furniture is being stored and in
order to save the furniture you pour significant amounts of water onto it, which causes
some damage to seat coverings but prevents far worse damage by fire.
In this situation you would not have time to call your friend to ask their permission to pour
water on their furniture, making you an agent by necessity.
Agency by ratification
Ratification refers to a situation where an agent acts without authority, but the principal
accepts the act as having been done by the agent on their behalf. The principal’s agreement
after the event is their ratification and they are bound by the contract to the third party.
Where this occurs the principal must ratify the whole contract and is not able to vary its terms
or pick and choose which elements to accept. This could occur where the agent has no
authority at all or is acting outside the terms of an agency agreement.
Ratification is the act by which the principal agrees the actions of the agent after the event,
basically making them acceptable retrospectively within the terms of the agency agreement,
although they were not when they were actually performed.
Example 8.2
An agent has authority to buy vegetables for their principal, but one day they come back
from the shops with not only vegetables but also meat and chocolate. The agent has
acted outside their contract as they don’t have the authority to buy meat and chocolate for
their principal.
Their principal could refuse to accept both the meat and the chocolate as it was bought
without their authority. If the principal decides to ratify their agent’s actions, they must
accept both the meat and the chocolate, they cannot pick and choose.
Question 8.1
A broker is advised by the insurer that one of the terms of their client's policy needs
to be amended. They agree to this but do not tell their client. When their client finds
out, they are agreeable to the change made.
What type of agency does this create?
a. Agency by requirement. □
b. Agency by necessity. □
c. Agency by ratification. □
d. Agency by default. □
For reference only

Activity
If you work for a broker, find out how you obtain instructions from your clients. Are they
always absolutely clear?
A3B Relationship of agent to principal

In most cases, an agent represents only one of the contracting parties. In some unusual
cases where the broker has been granted some authority by the insurer (for example claims
settlement authority up to a certain level), then they are acting for both the client and the
insurer and they must be careful to avoid any 'conflict of interest' between them.
Chapter 8
Activity
What practical steps can a broker take to ensure that conflicts of interest are minimised if
it has claims settlement authority from an insurer?
A3C Agent of the insured

An independent intermediary is considered to be the agent of the insured when the
intermediary gives advice:
• on cover or the placing of the insurance; or
• to the insured as to how to make the claim.
A3D Agent of the insurer
An independent intermediary is considered to be the agent of the insurer when the
intermediary:
• can bind cover, i.e. has the authority of the insurer to accept risks as if they were the
insurer themselves; and/or
• has authority to collect premiums and does so.
A4 Duties of an agent
An agent has the following duties to their principal:
• Obedience. One of the prime duties owed by an agent to their principal is the duty to
obey instructions. If the agent fails to comply, they are liable to be sued by their principal
for damages.
• Personal performance. As a general rule, an agent must perform the duties imposed on
them by the agency. The special nature of the relationship between principal and agent
means that they cannot delegate their duties to someone else (although purely
mechanical tasks may be delegated). In practice, an agent for the placing of an insurance
risk is a company. The particular individual who meets with the client is not expected to
carry out all the negotiating and placing functions: it is often market practice for these
tasks to be given to specialists in the company.
• Due care and skill. A person must exercise due care and skill in the performance of all
acts done in the course of their duty as an agent. An independent intermediary is a
person who claims to be a specialist in insurance and must, therefore, offer a higher
standard of ability than someone whose main profession is not insurance.
• Good faith. An agent’s relationship with their principal is one of trust. It follows that they
must not allow their own interest to conflict with their duties towards their principal. Agents
must not accept bribes or secret commissions.
Activity
Search for the term ‘contingent commission’ on the internet and read about the issues that
have been caused by such commissions in the market.
• Accountability. An agent must account to their principal for all money they receive on
their behalf, and must keep a proper record of all transactions.
For reference only

A5 Duties of a principal
A principal has the following duties to their agent:
• Remuneration. The agent has a right to the remuneration agreed by their principal or, if
none has been fixed, to a reasonable remuneration as is customary or appropriate. For
insurance transactions the remuneration usually consists of commission, and to earn this
the agent must prove that they were the effective cause of any transaction. Essentially, an
agent has not ‘earned’ their commission until a contract has been signed.
Where an intermediary/broker has provided some additional services such as risk
management advice then a fee may be chargeable to the client.
In the case of insurance, it is customary for the insurer to pay a commission to
intermediaries known as brokerage.
Chapter 8
The overarching obligation of an agent not to make a secret profit applies in addition to
any regulatory obligations. Under ICOBS 4.4.1, if a commercial client requests, an
insurance intermediary must disclose the level of commission they have received either
as a cash value or by means of a calculation.
Article 19 of the Insurance Distribution Directive (IDD) provides that: ‘in good time before
the conclusion of an insurance contract, an intermediary must disclose to the customer
whether it is representing the customer or is acting for and on behalf of an insurer.’
Reinforce
Do you remember that the regulator (FCA) distinguishes between commercial clients and
consumers? To refresh your knowledge, refer back to Fair treatment of customers on page
6/6.
• Indemnity. Subject to any express terms in the agency agreement, an agent has a right
to claim from their principal an indemnity against all expenses or loss incurred when
acting on the principal’s behalf.
A6 Undisclosed principal
In most situations it is clear that an agent is acting not on their own behalf, but as an agent
acting on behalf of a principal. English law permits an agent to act for an undisclosed
principal, whilst seeming to act on their own behalf. The agent must have authority to act on
behalf of the undisclosed principal at the time the contract is made for it to be effective. In
other words, the terms of the agency agreement must be clear between the principal
and agent.
In reality, in the London Market, given the importance to the consideration of the risk of
knowing the identity of the insured, the ‘undisclosed principal’ will rarely be encountered.
Whilst clients may appear to be ‘hazy’ by using companies to own assets which in reality are
owned by a multi-millionaire who likes their privacy, it is usually clear that the broker is
merely the intermediary.
A7 Consequences of an agent’s actions

The consequences of an agent’s actions on the principal depend on the particular
circumstances. Influential factors will be the extent of the agent’s authority: whether there is
actual authority, apparent authority or no authority.
A7A Actual authority
Actual authority may be express or implied, as follows:
Express authority arises from the terms of an agency agreement, which may be oral or in
writing. As already indicated, it would be unusual for this to be oral in an insurance context;
all terms would be expressed in a TOBA.
Implied authority may be one of two kinds. If the agent has to undertake a certain action
in order to carry out express instructions, they will have implied authority to do so. So, for
example, if an agent needs to travel to a particular place to carry out the principal’s
For reference only

instructions, the travel costs will be met without any need to have specific agreement on this
aspect. On occasions, there is an authority that is usual for the particular situation or
business arrangement. This situation may result in problems in an insurance context should
an agent act outside the express terms of appointment. We shall consider this next.
A7B Apparent authority
It is unlikely that a third party will be aware of the extent of an agent’s authority. Since the
third party is often in no position to make any judgment about the extent of such authority,
the situation is catered for in law by what is termed ‘apparent’ authority, also referred to as
'ostensible' authority. There are different situations in which it may arise in an insurance
context.
Apparent authority is that which should come with a certain position in an organisation – for
Chapter 8
example a Chief Executive Officer (CEO) should have more authority than someone who is
not on the board.
Example 8.3
A good example is where a broker has been granted some delegated authority from an
insurer. That authority permits them to bind risks on the insurer’s behalf but may be limited
to certain types of business such as property insurance.
Any client dealing with the broker is not going to know (or even think to ask) the nature
and extent of the broker’s authority; therefore, the broker might exhibit apparent authority,
i.e. the ability to bind liability insurance business, whereas in reality their actual authority
was just for property insurance business. Should they bind such a risk, the principal may
well have to ratify the contract with the end client.
Here, the principal (insurer) ratifies the contract by subsequently accepting the actions of
the agent (broker), which were outside the agency agreement when they were actually
performed.
It is important that you recognise that even if the actions of an agent bind the principal to the
contract – if the agent is acting outside their authority, the agent is liable to the principal for
the agent’s actions.
Even if the principal decides for reasons of reputation/brand protection to ratify the contract
they still have the ability to pursue the agent for damages behind the scenes.
Question 8.2
A broker has been asked by their client to obtain some property insurance for them.
If the broker approaches an underwriter with a request for some liability insurance for
the same client, what type of authority are they using?
a. Practical. □
b. Real. □
c. Apparent. □
d. Normal. □
A8 Termination of agency
An agency may be terminated in a number of ways – the most common being:
• mutual agreement;
• termination by one party or the other; or
• death, bankruptcy or insanity of any of the parties.
Consider this…
Why might a client want to change brokers? Who does the broker need to notify if a client
terminates their relationship?
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It is important that all relevant parties are notified by the principal when an agency is
terminated. The rule of apparent authority can apply for some time after termination and
unscrupulous former agents may continue to commit their principal to further agreements.
Insurers may find themselves bound to contracts entered into by an agent who no longer has
any authority to act on their behalf.
B Regulation
Refer to
Regulation is also covered in chapter 6
Chapter 8
Insurance intermediaries are authorised and regulated by the Financial Conduct Authority.
The rules that relate to intermediaries (brokers) also apply to insurers in connection with their
mediation activities, i.e. their advice, promotion and sales functions. In this section we will
also look at the impact that Lloyd’s has on the regulation and registration of brokers working
in the London Market.
B1 Authorised persons
An intermediary wishing to offer independent advice must apply for direct authorisation by
the FCA. Once authorised, a firm is bound to abide by all FCA rules. These rules are
demanding, particularly in terms of financial accounting, training and competence and
reporting requirements.
Consequently, since their introduction there has been a great deal of consolidation in the
marketplace through sales and acquisitions of smaller firms of brokers. In addition, umbrella
organisations have been created that are known as ‘broker networks’. These vary in their
structure, but one model for this is that the umbrella organisation becomes the authorised
person and each ‘member’ (the broker) of the network becomes an Appointed
Representative, thus availing itself of the centralised facilities and associated costs.
The FCA takes the position that its own rules are in addition to any legal duty of trust that an
agent owes to a principal.
B2 Appointed representatives (ARs)

An appointed representative (AR) may be an individual or a company that is appointed by
an authorised person under the terms of a contract. An AR may be acting for an intermediary
that is itself directly authorised by the regulator.
The TOBA determines the appointed representative’s role and responsibilities. The key
feature is that the principal takes responsibility for the appointed representative’s activities in
carrying on the business of the principal.
In late 2021 the FCA launched a consultation with the aim to improve the AR regime and to
tackle customer harm from the model. According to the FCA, they want to ensure that the
benefits in terms of cost and innovation are maintained, while improving the oversight
provided by principals, as well as the reporting provided to the FCA. To support this new
work, the FCA have also set up a new dedicated team to handle the new work that this
strategy will generate.
B3 Lloyd’s insurance brokers

It is worth pointing out at this stage that the term ‘broker’ is frequently used in the insurance
market. At one time it was necessary to be formally registered to use this term. Nowadays, in
practice it tends to be only those offering truly independent advice that use the term in
their title.
Although the term ‘broker’ may be freely used in the market, it is the Council of Lloyd’s that
registers insurance broking firms to act as Lloyd’s brokers. This title and distinction from non-
Lloyd’s brokers still exists, even though access to Lloyd’s has been granted to a wider range
of intermediaries by virtue of Legislative Reform (Lloyd’s) Order 2008.
To be registered, brokers must satisfy the Council as to their expertise, integrity and financial
standing. Once appointed the words ‘and at Lloyd’s’ may be used on the firm’s letterheads
For reference only

and name plates. The requirements of Lloyd’s are in addition to those of the FCA for
authorised persons. However, Lloyd’s no longer has its own separate code of conduct for
Lloyd’s brokers, relying instead on the regulator’s rules for authorised persons.
Consider this…
Given that it is no longer a requirement to be a Lloyd’s broker to work in Lloyd’s, what are
the benefits of being a Lloyd’s broker? Ask senior colleagues what they think. Is it a
branding issue?
B4 Wholesale and retail brokers

Although non-Lloyd’s brokers are now allowed to access the Lloyd’s Market, in the wider
London Market, there is often a chain of brokers between the insurer and the ultimate client.
Chapter 8
This is often to do with the geographical spread of business coming into the market. Here,
the client contacts a broker in their own region, the broker knows that the London Market is
the best option for the client and therefore links up with another broker to access that market.
The broker with the direct contact with the client is known as the retail broker and their
colleague who has the contact with the insurer is known as the wholesale broker. It is
possible for these roles to be performed by two offices of the same broking firm.
B5 Regulation of intermediaries
Once authorised, an intermediary will be supervised in an ongoing manner by the FCA. The
FCA has operational objectives and it assesses the risk to those objectives presented by any
authorised firm. The higher the perceived risk, the closer the supervisory relationship that the
FCA has with the firm concerned.
Should an intermediary fail to comply with FCA rules, then the FCA can take the following
actions:
• withdrawing that firm’s authorisation;
• disciplining both individuals and firms;
• imposing penalties;
• applying to the court for injunctions (a court order requiring certain action to be stopped);
and
• prosecuting the firm.
Activity
If you work for an intermediary, ask your compliance officer what supervisory contact your
employer has had with the FCA.
C Services provided by intermediaries

In the London Market, the main distinguishing feature of an independent intermediary (which
includes Lloyd’s brokers) is the fact that the intermediary is acting on behalf of the client
when placing business, not on behalf of the insurer in introducing the business. The
expertise of the independent intermediary is, in part, demonstrated by making a
recommendation as to the most appropriate insurer with which to place the risk.
C1 Services provided to clients

The intermediary must be capable of offering advice on the basis of a fair analysis of the
market. It is important to remember that the available market is not always London. This
does not mean that they do so in every case. However, there is an obligation under the
For reference only

regulatory rules to make available a list of product providers, if the market has not been fully
explored and only a restricted number of insurers approached.
Perhaps surprisingly, the broker also acting as the agent for the insured is usually paid by
the insurer as well. This payment, already mentioned in section A, is known as brokerage
and is traditionally a percentage of the premium payable. Increasingly however, there is a
tendency for intermediaries to charge clients a fee for their services instead (in which case
they would rebate to the client the brokerage received from the insurer or agree a net
premium with the insurer).
The services that intermediaries provide for their clients vary considerably. If we consider
independent intermediaries (such as London Market brokers) first, they will all carry out the
following functions:
• review the client’s needs;
Chapter 8
• advise whether the risk is insurable;
• decide the best market for the risk;
• negotiate terms and conditions;
• provide advice to the client (for example, concerning the wording of the policy);
• negotiate renewals; and
• advise and assist clients in relation to claims matters.
There are further services that may be provided and these will be specified in the TOBA
agreed with the client. They include such things as:
• risk management advice; and
• recoveries.
Reinforce
‘Recoveries’ means the same as subrogation – refer back to chapter 2 for the principles
involved with this. ‘Recoveries’ tends to be the term used in the marine market and
subrogation in the non-marine market.
C2 Services provided to insurers

So far, we have considered the services provided to clients. Other functions may be carried
out by the intermediary on behalf of insurers, depending upon the TOBA with the insurer.
These could include:
binding risks issuing settling claims collecting

(if authorised documentation (if authorised premium
perhaps, perhaps,
under a under a
binding binding
authority) authority)
C3 Schemes and delegated authority

Many insurers have delegated some authority to intermediaries to act on their behalf.
Some delegated authority schemes (often called ‘binders’ or 'binding authorities') give a
great deal of flexibility to the intermediary within defined limits. Often the policy wording is
specially negotiated to fit a particular category of client, e.g. haulage contractors, warehouse-
keepers and hoteliers. The attraction of these schemes for an insurer is a flow of business
arising from the tailored wording. There may also be an agreement on rating, but many
schemes rely upon individual rates being provided by the insurer upon receipt of proposal
information. Advantages for the intermediary are:
• the ability to grant immediate cover;
• ease of operation; and
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• (quite often) some kind of profit-sharing provision if the results of the scheme are good.
D Broker’s role in the placing process

In this section we will review the practical role of the broker in the placing process, overlaying
the theory reviewed earlier in this chapter.
D1 Initial enquiry from the client

On receipt of the initial enquiry from the client, the broker should be reviewing the client’s
requirements with them and considering the options, in terms of available markets and
potential types of insurance. Whilst this syllabus and study text are focused on the London
Market, it is important to appreciate that there are insurance markets worldwide. A good
broker (particularly for commercial risks) should never just consider their ‘home market’ as
Chapter 8
the only option – as that may not be the best option for the client. Having decided that the
London Market is a viable option to investigate for this client, the broker can move onto the
next step in the process.
D2 Presentation of the client’s risk to insurers

The broker puts together a summary of the risk into a document which is still colloquially
called a ‘slip’, although its proper name is now the Market Reform Contract (MRC). This sets
out the key information in a standardised form for presentation to insurers, but can be
supplemented with additional material relevant to the risk in question – for example, proposal
forms (although these are only used in certain types of commercial insurance) and survey
reports.
Reinforce
How much can you remember about the obligation under the Insurance Act 2015 to
make a fair presentation and the need for full and frank disclosure of the risk being
presented? If you need to refresh your knowledge, refer back to Duties of disclosure
during contract negotiation on page 2/8.
It is important that brokers remember that their knowledge is imputed on their client under
the Insurance Act as knowledge that the insurer is deemed to have and should, if material,
share with the holders.
Under the Insurance Act, information known by the broker is also considered to be known by
their client, unless it is confidential information that the broker has obtained from another
source.
Increasingly (and particularly driven by the problems caused by COVID-19) the presentation
to insurers will be wholly or partly via one of the electronic placing systems in use in the
London Market such as PPL or Whitespace. In these situations the information that needs to
be provided to insurers is exactly the same, it is just the method of presentation that has
changed.
Consider this…
What do you think the broker should do in this scenario? Always double check with their
client what information they have?
D3 Which insurers to approach?

One of the key benefits of using a broker is that they know the market and the insurers within
it. In the next chapter we will review in more detail the concept of a ‘subscription market’
where more than one insurer takes a share in the same risk, but the key for the broker is to
know the right combination of people to make enquiries with to obtain cover for their client’s
risk. There are no market rules banning brokers from approaching a combination of Lloyd’s
and company market insurers, or mixing providers in the London Market and overseas
market. It is entirely down to the broker’s skill and knowledge to ensure that they obtain the
best terms and conditions for their client – and of course that they use insurers that are going
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to still be in business when a claim needs to be paid.
Refer to
Compensation schemes are covered in The Financial Ombudsman Service (FOS) and
Financial Services Compensation Scheme (FSCS) on page 6/22
This final statement is possibly one of the most important. The broker must take care to
ensure that the insurers with which the risk is being placed are robust and will be around in
the future. Whilst there are various compensation schemes, the primary responsibility for
using secure markets is the broker’s. All brokers (even the smallest of firms) have
committees or at the very least a senior individual who will be constantly reviewing the
insurers’ financial stability and they will not use those that they feel are not stable enough.
This concept of security rating is covered in more detail in study text LM2.
D4 Quotations Chapter 8
In the same way as you would get a number of quotations for your own personal insurance,
a broker should obtain a number of quotations for their client’s business. These may vary not
only in terms of price but also in the coverage being offered and the market involved;
therefore, the broker needs to spend time explaining the differences to the client so that an
informed decision can be made as to which of them to accept, or whether in fact to reject
them all.
Once the client has decided which option to go for the broker can commence the process of
finally binding the risk.
D5 Binding the risk

Here, the broker contacts the insurers which provided the quote that was accepted and asks
them to confirm or ‘ink’ their line on the slip. Although the term ‘inking’ refers to the traditional
way of stamping and scratching (or initialling) a paper slip, in today’s market it is quite normal
to have both the quotation process and the final binding of insurers to the risks performed
electronically. In this case the binding would be done via the system and a timestamped
confirmation of the insurers agreement will be created.
Whichever way it is done, this final confirmation creates the contract between each insurer
and the client.
Question 8.3
If a client is using a Lloyd's broker, which markets can be used for the placement?
a. Just Lloyd's. □
b. Only the London Market. □
c. Only the London and European markets. □
d. Any market without restriction. □
D6 Central recording of the risk and payment of premium
When the broker revisits all the insurers again to get their ‘inked’ line, each of the insurers
takes a copy of the slip for its own records and enters some of the data in their computer
systems. If they have used an electronic placing system, a copy of the slip is in the system
together with date/time stamped confirmation of their agreement to participate.
The broker submits information about the risk to a company called Xchanging Ins-sure
Services (XIS) (now part of DXC). This organisation manages the central market databases
for risk data for both Lloyd’s and IUA companies, and also facilitates the movement of
premium funds centrally from brokers’ bank accounts to the various insurers’ bank accounts.
The information that has to be submitted to XIS (often just called ‘the Bureau’), includes the
slip and information about the premium to be paid, together with any taxes or similar sums
that have to be accounted for. Documents called London Premium Advice Notes (LPANs)
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are generally used to present the premium information in a standard format.
Historically, presentation to XIS was done by depositing a set of papers with them which
would be reviewed and returned, but now the system is almost completely electronic and a
system called Accounting and Settlement is used for the vast majority of the risk and
premium submissions by brokers, which involves a combination of scanned documents and
electronic messaging.
Whichever way the data is submitted by brokers to XIS, the end product is still the same.
The key data relating to the risk, including the identity of the brokers and the insurers,
together with the amount of the premium and any brokerage is recorded on the XIS
computer systems. Each night, every insurer is sent electronic messages advising them of
the data recorded that day on risks in which they participate.
The broker gives the risk a unique code, called a Unique Market Reference (UMR). This
Chapter 8
code is recorded and reported to insurers, along with the other information captured and
additional reference numbers relating to the transaction on the XIS system.
It is very unusual, however, for the broker to pay the premiums for the risk directly to the
insurers as the London Market has for many years, used centralised money movement
systems.
While all Lloyd's syndicates use this central system, it is optional for the company market,
although most participate. If an insurer chooses not to sign up to central settlement and data
movement then the broker has to account for premium to them individually and the insurer
has to capture all their own risk data into their own systems, The term used for these
insurers is non-bureau companies ('bureau' being the market term for the central services
DXC provide).
The system facilitates the movement of funds out of the broker’s bank accounts directly into
the insurers’ accounts and overnight messaging to both insurers and brokers advises them
that this is happening. It provides references that link transactions connected with a single
insurance contract to reconcile funds leaving one account and appearing in another.
In marine insurance contracts subject to English law, by virtue of the provisions of s.53 of the
Marine Insurance Act 1906, the broker is in fact responsible directly to the insurers for
payment of the premium. Clearly, this could put them in a difficult position should their client
refuse to pay for any reason. In practice this section of the Act is not invoked and insurers
can cancel contracts for non-payment of premium. Whilst the broker is usually the payment
route, this particular legal situation does not arise in any other class of business.
Although the detail is outside the scope of this syllabus, it is important to understand the
basic idea that in certain circumstances payment of premium to the broker is deemed to be
payment to the insurer. One impact of this is that the insurer cannot complain that it has not
received premium and try to cancel the contract. This topic is covered more fully in study
text LM2.
Be aware
As part of the market modernisation work, systems are being developed whereby some of
the different touchpoints are removed. An example of this is the Structured Data Capture
system which draws data directly from a scan of a Market Reform Contract and then
sends a formatted message directly to all the insurers involved. This prevents them each
having to manually enter from the MRC themselves.
Use this link to find out more about this: limoss.london/structured-data-capture-sdc
You can discover more about the work being done to standardise the data captured for
any risk in order to speed up the flow of data through the market at www.lloyds.com/
conducting-business/requirements-and-standards/core-data-record.
D7 Provision of documentation to the client

Once the placing process is complete, the insured should receive a document evidencing
their contract of insurance. This does not have to be a formal policy, although in some
countries this is still a requirement. The insurers on the slip (MRC) can indicate whether the
insured should receive a formal policy. If this is not required then the broker can issue either
a copy of the MRC or another evidence of cover; for example, a Broker Insurance
For reference only

Document (BID).
The BID is the summary of the risk provided to the client by their broker, which sets out the
key elements of the risk, rather than providing the client with either a copy of the full MRC or
a formal policy.
Activity
If you work for a broker, find a copy of a BID (or whatever document is sent to the client)
and compare it to the MRC to see what the client actually receives compared to the
documents used to place the risk.
The key point is that whatever the type of document ultimately issued, it must set out the
details of the insurance obtained and be provided to the client no later than 30 days after
Chapter 8
inception. (Note that for some personal-type insurances, this period can be as short as five
days, so it is important that the broker knows the requirements relevant to the particular
class of insurance.)
Refer to
Contract certainty is covered in Flow of business in the London Market on page 5/14
The requirement to provide documentation to the insured client is driven by a concept called
contract certainty. This is discussed more in study text LM2 but the core principle is making
sure that at the inception of the insurance contract all parties are clear as to the exact
details of the insurance agreement and that the client is provided with their paperwork
promptly thereafter.
Activity
Think about your own personal insurances (if you have them). You probably received
documentation directly from your insurers. However, in the London Market, the creation of
the final contract documentation is almost universally delegated by insurers to others,
whether that be the brokers or (if binding authorities are being used) the coverholder/
managing general agent.
What are the risks to the insurers of such delegation?
D8 Changes to the risk

If any changes are required during the life of the risk then the client should contact their
broker who will then approach the insurers to advise them of the changes and to obtain their
agreement. The agreement may be conditional on a requirement for more premium, or a
change in the terms and conditions; however, it could be that premium will be returned – for
example, if the change is that one of a fleet of ships has been sold and insurance for her is
no longer required.
Once the change has been agreed with the insurers, the broker sends the information to XIS
for recording, together with any necessary premium-related documentation. If a refund of
premium is required then XIS facilitates the money moving from the insurers back to
the broker.
E Broker’s role in the claims process

In this final section we will review the broker’s role in the claims process, again overlaying
the theory from earlier in this chapter with the practical application.
E1 Claims notification
For reference only

Should there be a situation which might give rise to a claim, the insured usually contacts
their broker. The broker plays a key role in assisting their client at this point – particularly in
relation to maintaining evidence and any emergency practical actions to be taken. Different
insureds have varying levels of knowledge and experience both of insurance and the claims
process and the broker will therefore have to provide differing levels of assistance across
their range of clients.
Consider this…
Personal lines customers (those purchasing household, motor and travel types
insurances) are using brokers less and less as they are buying their insurances direct
from insurers. Potentially, however, they would benefit the most from a broker’s expert
advice at the time of a claim.
Chapter 8
At the first possible opportunity the broker advises the relevant insurers. The London Market
has various claims-handling agreements which mean that it is not necessary for a broker to
see all the individual insurers to obtain their decisions on claims matters. The broker
contacts the necessary Agreement Parties to obtain their instructions which they then ‘route
back’ to their client. Agreement Parties are discussed in more detail in study text LM2.
The broker can additionally advise their client as to the correct way to present their claim –
for example, the documents that are required. Ultimately, this assists in streamlining the
process for both parties.
E2 Appointment of experts
Insurers often appoint experts to assist the client and also to report back facts and
information to insurers. These experts include surveyors, loss adjusters and lawyers, but the
exact combination of experts is determined by the claim itself. The experts' reports are also
usually routed back via the broker who:
• provides a copy to their client; and
• presents them to the insurers for any further instructions.
Clearly, with the broker being the agent of the insured, should the insurers wish to appoint
any experts to advise them concerning whether the claim is in fact covered under the policy,
they should not do so via the broker.
E3 Negotiation
Just as the placing broker negotiates the placement of the risk, the claims broker has a
negotiating role to play in those cases where the claim is not perhaps clear-cut. This does
not mean that the broker has to negotiate each time but they add considerable value to their
clients in negotiating points with insurers to assist with the resolution of the claim and to
ensure that the claims process is as smooth as possible.
They also assist insurers, in that they can (where necessary) explain to their clients exactly
why certain aspects or even the whole claim may not be covered.
Question 8.4
In which key way can brokers assist their clients in the claims process?
a. Paying the deductible for the client. □
b. Negotiating with the insurers. □
c. Collecting evidence from the loss location. □
d. Filling in forms. □
E4 Claims data
In the same way that risk data is centrally recorded by Xchanging from presentations made
For reference only

by brokers, claims data is also centrally recorded – but done in a slightly different way
depending on whether the insurers come from the Lloyd’s or company market.
For the Lloyd’s Market, another Xchanging company – in this case Xchanging Claims
Services (XCS) – maintains the Lloyd’s central claims database. The database is populated
using presentations made by brokers, which can be in paper or electronic form, with the
emphasis on using electronic presentations unless absolutely unavoidable. Each night, data
is sent out to each syndicate, populating their internal systems with data on claims that have
been updated during the day. The syndicates cannot access the XCS system and can only
see the first system the brokers enter the data into at the front end of the process – the
Electronic Claims File (ECF) system.
While there is no separate central database for the company market, claims data is sent by
the brokers to the individual company market underwriters electronically as well as via paper
submissions. The difference with the Lloyd’s Market is that the system into which brokers
Chapter 8
enter data is the same system that sends the overnight message data into the company
insurers’ systems and in which the individual insurers can view their own claims data,
perhaps to compare with information in their own individual organisation’s systems.
Confusingly perhaps, this is also ECF but a different version of it.
Be aware
There is a project ongoing in the London Market to develop a single market claims system
to replace ECF. This is part of a wider project to replace all the legacy systems currently in
use both on the placing and claims sides, to remove the disconnect for example between
Lloyd's and company market business.
Speak to colleagues and find out whether your organisation is involved in any of the work,
either by consultation, testing or anything else.
E5 Money movement
In the same way that premium funds are moved centrally by Xchanging, XCS move money
centrally for Lloyd’s insurers only. The system is exactly the same as for premiums, just with
the direction reversed. They take the data from the broker, put it into their own system, send
out messages and trigger money movement from that system.
For company market claims, once the correct combination of insurers agrees any particular
settlement request from the broker, the claims system on which the data is held actually
triggers money movement automatically.
Both claim payments and experts’ fees can be paid out using these systems. While
payments are generally made to the broker who requested them, money can be paid to non-
brokers as well – and often payments are made directly to lawyers and other experts. This is
done by putting a different routing code into the systems – making sure that it is
accurate first.
E6 Final stages of the claims process

The broker's responsibilities are complete when the client receives the claims funds 'in full
and final settlement' (and hopefully is happy, although this is not always guaranteed).
Depending on the type of claim, the insurers may be considering some subrogation or
recovery action and the brokers should remain in contact with them, as the insurers will often
include the amount of any deductible or an uninsured loss within a combined action. Clearly,
this will be of benefit to the insured as they might obtain refunds of these amounts if the
claim against a third party is successful.
E7 Legal changes impacting the claims process

The Enterprise Act 2016, which came into force on 4 May 2017, introduced a new remedy
for insureds who believe that their claims have been paid late. They have up to one year
after the claim was actually paid to file a legal action claiming damages for the late payment.
The Act introduces the concept of an implied term in every insurance contract that claims will
be paid within a reasonable time, taking into account the circumstances which will include:
• the type of insurance;
For reference only

• size and complexity of the claim; and
• any factors outside the insurers control.
A reasonable time also includes the time given to the insurers to review and assess the
claim and the broker’s role in trying to ensure that all the information required is available. In
negotiating with insurers, the broker will assist both parties in relation to ensuring that the
claims life cycle is no longer than it needs to be.
Chapter 8
Key points
Legal basis of the broker’s role
• Brokers are agents and are therefore subject to the general law of agency.
• Agency can be terminated by mutual consent, termination by one or other party, or by
death, insanity or bankruptcy of either party.
• Brokers are generally agents of the insured, but in certain cases they can be agents of
the insurers as well. For example, if they have a delegated authority of any kind.
• Agency can be created by consent, necessity or ratification.
• Brokers normally have Terms of Business Agreements (TOBAs) setting out the details
of their relationships with their clients and also with insurers.
• Agents and principals have some key responsibilities towards each other.
Regulation
• Brokers operating in the London Market are regulated by the Financial Conduct
Authority.
• Brokers do not need to be a Lloyd’s broker to operate in the Lloyd’s Market.
Services provided by intermediaries
• A broker is their client’s professional adviser.

• A broker can in certain circumstances be working for insurers particularly in relation to
delegated authorities.
For reference only

Broker’s role in the placing process
• In the placing process, the broker presents information to insurers and negotiates on
behalf of their client.
• A broker’s skill and knowledge will assist in the placing process.
• Premiums will generally flow through the broker in the London Market.
Broker’s role in the claims process
• In the claims process, the broker presents information to insurers and negotiates on
behalf of their client.
• A broker’s skill and knowledge will assist in streamlining the claims process.
Chapter 8
• Claims funds will generally flow through the broker in the London Market.
Question answers
8.1 c. Agency by ratification.
8.2 c. Apparent.
8.3 d. Any market without restriction.
8.4 b. Negotiating with the insurers.
For reference only

Chapter 8
Self-test questions
1. Who are the two main parties in a simple insurance transaction?
a. Insured and insurer. □
b. Insured and broker. □
c. Broker and insurer. □
d. Insurer and regulator. □
2. Who does the broker usually consider to be their client?
a. Whoever pays them more. □
b. Whoever engages them first. □
c. The insured. □
d. The insurer. □
3. If an agent acts outside their authority and their principal subsequently accepts their
actions, what is this act by the principal known as?
a. Validation. □
b. Justification. □
For reference only

c. Acceptance. □
d. Ratification. □
4. What is meant by the agent's duty of personal performance?
a. Only one person in an organisation being able to perform any tasks. □
b. Not delegating tasks that they have been asked to do without permission. □
c. Having regular meetings with their principals. □
d. Providing in-person reports on progress with their activities. □
Chapter 8
5. Which of these options is not a common way of terminating an agency agreement?
a. Reporting to the regulator. □
b. Mutual agreement. □
c. Bankruptcy. □
d. Death. □
6. Who regulates brokers in the London Market?
a. LIIBA. □
b. FOS. □
c. FCA. □
d. Lloyd's. □
7. What is the difference between a wholesale and a retail broker?

a. A wholesale broker is closer to the client and retail broker closer to the insurers. □
b. A wholesale broker can charge higher brokerage than a retail broker. □
c. A wholesale broker can charge higher brokerage than a retail broker. □
d. A wholesale broker is closer to the insurers and retail broker closer to the client. □
8. What is the technical term for the payment that brokers receive from underwriters?
a. Premium. □
b. Tax. □
c. Brokerage. □
d. Consideration. □
9. If the broker has started placing the risk in the London Market, are there any insurers
that they cannot approach?
a. Yes, they cannot now use any non-London Market insurers. □
b. Yes, they can only use UK based insurers but they do not have to be London □
Market.
c. No, they are free to approach any insurers they think are appropriate. □
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d. No, but they have to get the leader's permission to look outside the London □
Market.
10. How are brokers involved in the payment part of the claims process?
a. They will usually pay the claim in the first instance and then await the funds from □
insurers.
b. They receive the funds from insurers and pay them onto their client. □
c. They do not play any part in the claims payment process. □
d. They will perform all the required sanctions checks for insurers before payment is □
made.
Chapter 8

Underwriters
9
outcomes
Introduction
A Role of an underwriter 11.1
B Functions of an underwriter 11.1
C Subscription market 6.4, 11.2
Key points
Question answers
Self-test questions
Learning objectives
For reference only

• explain the role and responsibilities of underwriters; and
• explain the role and responsibilities of lead and following underwriters within the London
Market.
Chapter 9
Introduction
In this chapter we will be reviewing the role of the underwriter, the ‘subscription’ nature of the
London Market and some of the issues that can arise if the risk is placed over a number of
different contracts of insurance.
Key terms
Competition law Following market Leader Multiple placements

underwriters
Subscription market Scratch Underwriter
A Role of an underwriter
In its most straightforward role, an underwriter is the person who makes the decision on
behalf of an insurer whether to accept any risk presented. If the insurer accepts a risk, the
underwriter determines the terms and conditions on which the acceptance is made.
The term ‘underwriter’ comes from the historic system whereby supporters would write their
names under the details of any risk being presented (for example in the original London
coffee houses such as Edward Lloyd’s). By placing their name under the information on the
paper presented to them, they were said to be underwriting the risk.
The term ‘scratch’ is often used for the combination of initials and a date that underwriters
(and claims personnel) use to indicate that they have seen the presentation made. This term
comes from the sound that was made – often with a quill pen – when they wrote their name
For reference only

as underwriters.
In a modern insurance organisation, whether a company or a Lloyd’s syndicate, there will be
a number of underwriters – each with responsibility in their area of specialty, who are all
employed by the investors in the business to accept risks (and hopefully make profits). In the
case of a Lloyd’s syndicate, they are employed by the managing agent which is the entity
responsible for managing the syndicate on behalf of the Names (the investors). Insurance
companies employ their own underwriters.
B Functions of an underwriter
When we looked at the nature of insurance in chapter 1, we talked about it as a ‘common
pool’ where the contributions (premiums) of the many (people) pay for the losses of the few.
In essence, the task of the underwriter is to manage this pool of premiums as effectively and
profitably as possible. The main functions of the underwriter are to:
• assess the risks being presented to the pool;
• decide whether or not to accept the risk and if so – how much of the risk to accept;
• determine the terms and conditions to be offered; and
• calculate an appropriate premium.
Chapter 9
C Subscription market
In the London Market, risks can either be placed 100% with one insurer (but this is rare) or
on a 'subscription basis'. This means that more than one insurer participates in the same
risk, each taking a fixed percentage of the risk.
Consider this…
Why might an insurer only want to take a small percentage of any risk?
Chapter 9 Underwriters 9/3
An underwriter may only take a proportion of any risk offered for a number of reasons, as
follows:
• Size of risk and authority levels – each underwriter has a level of personal authority
granted to them by their employer, i.e. a maximum share in financial terms of any risk
which they can accept.
• Balancing the portfolio – all underwriters constantly monitor their business to ensure
balance across such areas as geographical exposures. It may be that the business
already on the insurer’s books almost fills the available capacity to insure a risk in a
certain part of the world, so only a small amount of any later risk can be accepted.
• Insurance broker input – it might be that a risk is very good and the broker wishes to
spread it amongst many insurers. The broker therefore tries to ensure that no insurer
takes an overly large share for itself.
• New class of business – if an insurer is just starting out in a certain class of business
then it is more prudent to take smaller shares in a number of risks in order to spread the
exposure of its pool.
There are no rules as to the combination of insurers on any one risk and these combinations
can include both London Market insurers as well as those from overseas markets. In cases
where the insured is based overseas, it is quite common for the risk to be placed partially in
their home market and then any balance remaining being presented to the London Market.
Mutual market
The notable exception to the concept of a subscription market is the Mutual Insurance
sector, where the vast majority of the risks are accepted 100% by one insurer (e.g. the
Protection & Indemnity Clubs).
For reference only

In a subscription market, part of the broker’s skill is to identify the best underwriter to
approach first, to be the leader (or ‘lead’ or ‘leading’). The leader’s role is to:
• review the risk presentation being made by the broker;
• consider whether or not to accept it;
• decide the terms and conditions upon which to accept the proposal; and
• quote a premium.
The broker may approach a number of potential leaders to ascertain whether there is any
significant difference in the terms and conditions that they are prepared to quote; they then
present these to the client for their consideration.
Activity
Visit the website of an aggregator such as www.comparethemarket.com or
www.gocompare.com and make a request for insurance. See how various options for
possible insurance are presented to you. This is exactly the same concept as a broker
presenting the quotes to their clients.
Question 9.1
Chapter 9
Which of these tasks is not the responsibility of the leading underwriter?

a. Finding following markets. □
b. Calculating the premium. □
c. Deciding on the terms and conditions. □
d. Considering the 'slip' (MRC). □
C1 Characteristics of a good lead underwriter

The broker looks to the leader to put together an appealing quotation for the client, but if the
leader does not accept 100% of the risk, the broker will then have to present it to other
underwriters to see if they will support the quotation.
It is therefore essential that the leader is both able to provide a good quotation to the client
and at the same time be credible and supportable by what is known as the ‘following
market’. It is of no value to the broker to have a leader who has provided a quotation that
no-one in the following market will support – meaning that the risk cannot be placed on those
terms and conditions.
C2 Following market underwriters

A following market underwriter is one who is not deemed to be the leader. However, it is
important to appreciate that each underwriter who takes a share of the risk is creating a
separate and distinct contract of insurance between their insurer and the insured – and they
must consider the risk for themselves before they make that commitment.
While standard practice is that the following market underwriters agree with and support the
leader’s position, it is entirely possible that a following market underwriter might request
more premium before agreeing to support the risk. If the risk is popular and the broker is not
concerned about obtaining enough support from underwriters, the easy solution is not to use
that underwriter. However, if the risk is proving more difficult to place, then the broker may
need that underwriter to take a share of the risk.
Consider this…
What do you think happens next? Do you think that the leader and all the other followers
should also get more premium? The answer to this conundrum is contained within
principle 4 below.
For reference only

The answer is not an automatic yes (unfortunately) as the leader and followers up to that
point were fully prepared to write the risk on the lower premium terms and it would be
prejudicial to the client suddenly to increase the whole premium on that basis.
The legal background for this principle is a concept called ‘competition law’. Put more
practically the law prohibits behaviour whereby the normal competitive nature of the
insurance market is removed. It is also trying to prevent a situation where the market acts
together to the detriment of the client.
The European Federation of Insurance Intermediaries (BIPAR) put together some high-
level principles concerning the placement of business with subscription markets and these
are set out in the following:
1. The intermediary shall, based on information provided, specify the demands and needs of
the client as well as the underlying reasons for any advice.
2. Before placing a risk, an intermediary will review and advise a client on market structures
available to meet its needs and, in particular, the relative merits of a single insurer or a
multiple insurer placement.
3. If the client, on advice of the intermediary, instructs the latter to place the risk with multiple
Chapter 9
insurers, the intermediary will review, explain the relative merits and advise the client on a
range of options for multiple insurer placement.
Intermediaries will expect insurers to give careful independent consideration to the option
requested.
4. In the case of a placement of a risk with a lead insurer and following insurers on the same
terms and conditions, the previously agreed premiums of the lead insurer and any
following insurers will not be aligned upwards should an additional follower require a
higher premium to complete the risk placement. Indeed, the intermediary should not
accept any condition whereby an insurer seeks to reserve to itself the right to increase
the premium charged in such circumstances.
5. During the placement of the risk, the intermediary will keep the client informed of
progress.
As you can see from principle 4 the underwriters who previously agreed the lower premium
cannot suddenly ask for more money just because someone else has successfully done so.
Consider this…
Although the UK has left the EU, the principles are good practice regardless of the
regulatory perspective. If you work for a broker, discuss with your compliance colleagues
what impact leaving the EU might have on the application of these principles.
C3 Multiple placements
Even with the principles set out above, there will be situations where the insurers subscribing
to the risk have agreed slightly different terms and conditions, whether that be the premium,
the deductible or even the brokerage to be paid to the intermediary. If so, the practical result
is that the broker must prepare and present multiple sets of information to Xchanging for the
risk recording and premium transfer process.
C4 Handling changes to risks

In a traditional single placement the leader is easily identified and their role does not end
with the placement of the original risk. It is important at this point to distinguish between the
overall leader, the slip leader and the bureau leader:
• Overall leader. Earlier in this section we discussed the importance of the leader’s
credibility to other underwriters in addition to their ability to set terms and conditions
acceptable to the clients. In the London Market, the overall leader of a risk may in fact be
overseas and when the broker presents the risk to the London Market underwriters they
will tell them the terms that the overall leader has set.
• Slip leader. The London Market underwriters are not obliged to follow the overall leader’s
terms – but for the moment we will assume that they do so. The broker may have gone to
see a London Market leader in either the Lloyd’s or the company market. If that
underwriter is happy to lead the broker’s London Market slip, they become the slip leader.
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• Bureau leader. As we have already seen, there are no rules around combining Lloyd’s
and company underwriters on a slip with London Market security on it. If the slip leader is
from a company then the first Lloyd’s underwriter on the slip is called the bureau leader
for Lloyd’s and the slip leader is also the bureau leader for the company market (and vice
versa for the company market if the slip leader is from Lloyd’s).
This division of the London Market into Lloyd’s and companies remains important insofar that
the Market has a number of internal operational rules which seek to streamline the process
for agreeing and advising changes to the risk, and the handling of claims. These will be
discussed in more detail in study text LM2, but the key to all the rules operating smoothly is
the easy identification of the key Agreement Parties for either changes to the risk, or to
claims.
Within the structure of the slip/MRC there are sections for the parties to identify those who
will be agreeing post inception contract changes or handling claims. An example of what this
section would look like, as well as the LMA9150 single claims agreement party clause the
form references, are available on RevisionMate.
Post bind changes in particular are matters which brokers generally want to have managed
as efficiently as possible, and one way to do that is to streamline the number of decision
makers who have to be involved. The General Underwriters Agreement (GUA) referenced
Chapter 9
above is a default mechanism which divides changes into three categories being:
• Part 1 – non-material changes which will be agreed leader only.
• Part 2 – anything not in part 1 or part 3 generally which is leader and some agreement
parties.
• Part 3 – material changes which should be agreed by all underwriters.
Any number of insurers can add themselves to the Part 2 agreement parties, but the broker
would usually prefer a smaller number. There is no problem with the GUA not being used at
all and another wording being used, perhaps allowing for any and all post-contract changes
to be agreed slip leader only.
Consider this…
If you are a follower and all changes are slip leader only – how will you find out about
them? Do you hope you will get a copy of the endorsement showing the change sent to
you, might you see a premium payment coming through, or might you not know at all until
a claim comes in? Does the use of an electronic system make notification easier through
automated messages?
If you work for an insurer speak to some colleagues to find out how you are advised of
changes when you are not the leader.
If you work for a broker find out what is required to ensure all underwriters know about the
changes, even if they are not agreeing to them personally
The leader is always involved in risk changes, but if you have a number of separate slips that
have been created because of differences between the terms and conditions, then multiple
leaders will have been created almost inadvertently. This causes difficulties – particularly
with electronic trading – as far more parties have to be involved, which was never the
intention.
Example 9.1
The broker starts the placing process by approaching insurer A with their slip. Insurer A
agrees to take 25% of the risk but wants a deductible to be applied of £100. Broker then
goes to insurer B, who is prepared to write another 25% of the risk but they want a
deductible of £200. Insurers C and D agree with B about the level of deductible.
The broker will treat the insurers separately and create two separate risk records with
unique references.
In reality, insurer B never wanted to be a leader, but because they wanted different terms
For reference only

from Insurer A, they end up ‘leader’ of a contract with insurers C and D; insurer A is on its
own on a separate contract.
Question 9.2
What is the name given to the leader of the London Market part of any insurance
placement?
a. Overall leader. □
b. Slip leader. □
c. Market leader. □
d. Main leader. □
C5 Identifying the agreement parties for claims
As with risk changes, the London Market has in-built claims-handling agreements which
seek to streamline the process. However, the market rules always apply and, unlike risk
Chapter 9
changes, insurers cannot add themselves to the decision-making group automatically.

The rules differ between the Lloyd’s and company markets and will be discussed
more in study text LM2; however, for each market the leaders are always involved as
decision-makers. If the risk ends up being spread across a number of slips because of slight
differences in the terms and conditions (which might have no impact on whether a claim is
covered), multiple leaders will appear by default and the process has the potential to be
slowed down rather than speeded up.
In February 2018 a new clause was introduced called ‘Single Claims Agreement party’
(SCAP) which allowed the subscribing insurers to agree at the time of placing that claims
that were eligible could be agreed by a single insurer only. This insurer would be called the
slip leader. However they must be either a Lloyd’s syndicate or a UK authorised insurer (not
necessarily an IUA member company).
On the Web
To read more on SCAP, visit www.londonmarketgroup.co.uk/scap.
Particularly with the use of electronic claims handling, the existence of more than one slip for
any one risk creates ‘ghost’ leaders who suddenly have to become involved in claims-
handling where they never intended to be when they originally wrote the risk. Whilst the
various slips can indicate that one of them is deemed to be the leader and the others to be
subordinate (i.e. not to be involved in any agreement) the systems cannot currently easily
deal with that scenario as the mechanisms to link different risks and their claims together do
not exist unfortunately.
Changes to the market electronic claims systems are being discussed which would address
a number of these issues.
For reference only
Chapter 9
Key points
Role of an underwriter
• Underwriters make the decision on behalf of the insurer as to whether to accept risks
and on what terms and conditions.
• An insurer will employ a number of underwriters – each with an area of specialty.
Functions of an underwriter
• Main functions of the underwriter are to:

– assess the risks being presented to the pool;
– decide whether or not to accept the risk and if so – how much of the risk to accept;
– determine the terms and conditions to be offered; and
– calculate an appropriate premium.
Subscription market
• The underwriter who is approached by the broker to set the initial terms and conditions
is called the leading underwriter or leader.
• There can be an overall leader outside the London Market, as well as a slip leader
inside the market.
• The bureau leaders are the first Lloyd’s and the first IUA company on the slip.
• Following market underwriters (‘followers’) are those who are not leaders.
For reference only

• Followers are not obliged to accept the risk on the same terms as the leader and
should always consider the risk independently.
• A follower can request more premium as a condition of their writing the risk, but the
leader and previous followers cannot automatically receive more if this is the case.
• Market agreements exist to streamline the process for agreeing changes to the risk
and for claims.
• Multiple leaders created by different terms and conditions being agreed by different
insurers in the Market reduces the effectiveness of these agreements.
Chapter 9
Question answers
9.1 a. Finding following markets.
9.2 b. Slip leader.
For reference only
Chapter 9
Self-test questions
1. Which of these options is not a main function of an underwriter?
a. Assessing the risk. □
b. Finding the following market insurers. □
c. Setting terms and conditions. □
d. Setting premiums. □
2. What does the term 'subscription market' mean?
a. A market reform contract is being used. □
b. Only one insurer is involved in the risk. □
c. More than one insurer is involved in the risk. □
d. Only London Market insurers are being used. □
3. What is BIPAR?
a. The European federation of insurance intermediaries. □
b. The European federation of insurance companies. □
□
For reference only

c. The European federation of insurance regulators.
d. The European federation of insurance buyers. □

4. If the second underwriter that a broker approaches requests more premium than the
first underwriter, should the broker return to the first underwriter to see if they also
want more premium?
a. Yes, because the 100% premium for each insurer should always be the same. □
b. Yes, because the leader will probably want to increase their price to match. □
c. No, as it would contravene BIPAR rules. □
d. No, because once the leader has seen it once they cannot see the risk again . □
5. Which of these is the most likely reason that an insurer would not take 100% of any
one risk?
a. Overall size of the risk exposure. □
Chapter 9
b. Class of business. □
c. Currency of premium. □
d. Relationship with the broker. □
6. What is the bureau leader?

a. Overall leader of the whole risk, irrespective of marketplace. □
b. Leader of the portion of the risk placed in the London Market. □
c. Leader of the individual section of the London Market, i.e Lloyd's or company □
market.
d. Insurer identified to be involved with certain administrative tasks only. □
7. Which organisation is involved in recording risk data for insurers and transferring
premium from the brokers to the insurers?
a. LIIBA. □
b. LMA. □
c. XCS. □
d. XIS. □
8. If an insurer is not a leader, what is the term used for it?
a. Subscriber. □
b. Follower. □
c. Participant. □
For reference only

d. Contributor. □
Chapter 9
For reference only
i
Chapter 1
self-test answers
1 c. Moving the financial impact of a loss to insurers.
2 d. Reducing the operating costs of a business.
3 a. Low speed car crash.
4 c. A non-financial risk.
5 a. Peril causes the loss and the hazard can possibly make it worse.
6 b. A pure risk is one where there is no possibility of a positive outcome.
7 d. Fortuitous event.
8 c. To enable them to charge each client a fair premium.
9 d. Investment in the insurance industry.
10 a. Third party motor.
For reference only

ii EP2/October 2022 London Market insurance essentials (EPA)
Chapter 2
self-test answers
1 a. Documentation in English.
2 a. Premium.
3 c. The legal relationship between an insured and the subject-matter of insurance.
4 b. The insured sharing material information with insurers.
5 a. Misrepresented the risk.
6 d. The dominant and operative cause of the loss.
7 c. Returning the insured to the position they were in before the loss.
8 b. Subscription.
9 a. Deductible.
10 d. Recklessly breached the duty of fair presentation.
For reference only

iii
Chapter 3
self-test answers
1 a. Builders risk.
2 b. Fine art.
3 d. Only driving in daylight.
4 b. Assets being seized by authorities.
5 a. Fidelity guarantee.
6 c. Loss of income following physical damage to a factory.
7 d. Public liability.
8 b. It is a benefit policy, not an indemnity policy.
9 a. Professional negligence.
10 c. All the risks written by the insurer.
For reference only

iv EP2/October 2022 London Market insurance essentials (EPA)
Chapter 4
self-test answers
1 c. Supply is the provision of something and demand is the need for something but only
at a certain price.
2 d. Using only online advertising.
3 b. Motor.
4 a. Just enough supply to meet demand.
5 b. Rates will increase.
6 c. Supply will reduce as insurers leave the market.
7 a. Greater demand will be created.
For reference only

v
Chapter 5
self-test answers
1 b. Members.
2 a. The syndicate bears the risks and the managing agency runs the day to day
business.
3 d. Management and supervision of the Lloyd's market.
4 a. Members' agents.
5 a. A measure of the size of the insurer based on how much business it can accept in a
year.
6 b. Mutual indemnity association.
7 b. The insured.
8 d. Managing agents.
9 c. LIIBA.
For reference only

vi EP2/October 2022 London Market insurance essentials (EPA)
Chapter 6
self-test answers
1 a. The FCA and PRA.
2 d. Ensuring that insurers are profitable.
3 b. Have a head office in Europe.
4 c. Paying due regard to the interests of the customer.
5 a. Letting the authorities know of dangerous machinery being used in a factory without
suitable training.
6 a. Allowing an insurer regulated in their own country to operate freely within the rest of
the EU.
7 d. Lloyd's obtains the permission centrally.
8 b. Management of all Lloyd's affairs.
9 d. Executive.
10 c. FSCS.
For reference only

vii
Chapter 7
self-test answers
1 b. Amount of gross premium paid.
2 d. Salary limits.
3 b. Financial and trade.
4 a. The part of the US Government that issues sanctions related guidance.
5 b. Insurers with US parents need to be aware of US sanctions.
6 c. Terrorist financing.
7 d. Permission from the person concerned.
8 a. Placement, layering and integration.
9 b. Request to pay claims proceeds to someone not previously involved.
10 d. Taking a bribe, bribing others, bribing a public official overseas and failing to prevent
bribery.
For reference only

viii EP2/October 2022 London Market insurance essentials (EPA)
Chapter 8
self-test answers
1 a. Insured and insurer.
2 c. The insured.
3 d. Ratification.
4 b. Not delegating tasks that they have been asked to do without permission.
5 a. Reporting to the regulator.
6 c. FCA.
7 d. A wholesale broker is closer to the insurers and retail broker closer to the client.
8 c. Brokerage.
9 c. No, they are free to approach any insurers they think are appropriate.
10 b. They receive the funds from insurers and pay them onto their client.
For reference only

ix
Chapter 9
self-test answers
1 b. Finding the following market insurers.
2 c. More than one insurer is involved in the risk.
3 a. The European federation of insurance intermediaries.
4 c. No, as it would contravene BIPAR rules.
5 a. Overall size of the risk exposure.
6 c. Leader of the individual section of the London Market, i.e Lloyd's or company
market.
7 d. XIS.
8 b. Follower.
For reference only

For reference only
xi
Cases
C
Carter v. Boehm (1766), 2D1C
Currie v. Misa 1875, 2B
H
Household Fire Insurance Co. v. Grant (1879),
2A2C
Hyde v. Wrench (1840), 2A2B
L
Leyland Shipping v. Norwich Union Fire
Insurance Society (1918), 2F1
Lister v. Romford Ice and Cold Storage Ltd
(1957), 2I4D
N
North British & Mercantile v. Liverpool &
London & Globe (1877), 2H3
P
Pawsey v. Scottish Union and National
For reference only

(1907), 2F1
Y
Yorkshire Insurance Co. v. Nisbet Shipping
Co. Ltd (1961), 2I1
xii EP2/October 2022 London Market insurance essentials (EPA)
For reference only

xiii
Legislation
B P
Bribery Act 2010, 7E Proceeds of Crime Act 2002 (POCA), 7D3,
7D5
Public Interest Disclosure Act 1998, 6B7
C
Carriage of Goods by Sea Act 1971, 2C2 R
Carriers’ Act 1830, 2C2
Consumer Insurance (Disclosure and Rehabilitation of Offenders Act 1974, 2D2
Representations) Act 2012, 2D1B Repair of Benefice Buildings Measure Act
Criminal Justice Act 1988, 7D3 1972, 2C2
Criminal Justice Act 1993, 7D3 Riding Establishments Act 1970, 1I3
Riot Compensation Act 2016, 2I2B
Road Traffic Act 1988, 1I2, 2D6
D
Dangerous Dogs Act 1991, 1I4 S
Dangerous Wild Animals Act 1976, 1I4
Serious Crime Act 2007, 7D3
Settled Land Act 1925, 2C2
E Solicitors Act 1974, 1I5A
Employers’ Liability (Compulsory Insurance)
Act 1969, 1I1 T
Enterprise Act 2016, 8E7
EU General Data Protection Regulation (EU Terrorism Act 2000, 7D5
GDPR), 7C2
Export Control Order 2008, 7B1A, 7B6
For reference only

F
Financial Services and Markets Act 2000
(FSMA), 7D5
First Motor Insurance Directive 1972 (EU), 1I2
Foreign and Corrupt Practices Act 1977
(USA), 7E
H
Helms-Burton Act 1996, 7B2A
Hotel Proprietors’ Act 1956, 2C2
I
Insurance Act 2015, 2D1C, 2D2, 2D5, 2D9,
8D2
Insurance Distribution Directive (IDD), 8A5
L
Legal Aid, Sentencing and Punishment of
Offenders Act 2012, 2D2
Legislative Reform (Lloyd’s) Order 2008, 8B3
Lloyd’s Act 1871, 6D1
Lloyd’s Act 1982, 5A1, 6D1
M
Marine Insurance Act 1906, 2D2, 2G5A
Money Laundering, Terrorist Financing and
Transfer of Funds (Information on the
Payer) Regulations 2017, 7D4
xiv EP2/October 2022 London Market insurance essentials (EPA)
For reference only

xv
Index
A capital adequacy, 6E1
captive insurance company, 3D6, 5B5
acceptance, 2A2 cargo insurance, 3A3A
conditional, 2A2B cash in transit insurance, 3A3G
postal, 2A2C cedant, 3D7
unconditional, 2A2A cede, 3D7
accounting and settlement, 8D6 Central Fund, 6F3
advanced loss of profits (ALOP) insurance, cession, 3D7
3B2A CII Code of Ethics, 1J
agency, 8A3 claims, 5G2, 9C5
by consent, 8A3A handling, 1J
by necessity, 8A3A personnel, 1J1
by ratification, 8A3A role of a broker
termination of, 8A8 collecting note, 3D7
agent and principal, 8A2 common law, 2C2
agreed value policies, 2G6A company market, 5B
AIRMIC, 1B compulsory insurance, 1I
appointed representatives (ARs), 8B2 employers’ liability insurance, 1I1
apportionment and Oversight Officer, 6B6 motor insurance, 1I2
Association of British Insurers (ABI), 5F2A professional indemnity insurance, 1I5
Association of Insurance Risk Managers, 1B public liability insurance, 1I3, 1I4
authorisation, consideration, 2B
of new brokers, 8B1 construction insurance, 3B1C
of new insurers, 6E Consumer Duty, 1J, 6B5A
authority, contingency insurance, 3B5
actual, 8A7A contract
apparent, 8A7B certainty, 5G1
For reference only

express, 8A7A creation of insurable interest under, 2C2
implied, 8A7A essentials of a valid, 2A1
ostensible, 8A7B law, 2A
average, 2G7C simple, 2A1
aviation insurance, 3C subject-matter of, 2C1A
airport operators’ policies, 3C4 termination of insurance contracts
liabilities, 3C2 cancellation, 2E2
loss of licence/loss of use, 3C3 fulfilment, 2E3A
physical damage, 3C1 voidable, 2E3B
contribution, 2H
condition, 2H1
B definition, 2H2
benefit policies, 2G2, 2I4B non-contribution clause, 2H4
BIPAR, 9C2 cyber insurance, 3B1E
bloodstock insurance, 3B4
bribery, 7E D
British Insurance Brokers’ Association (BIBA),
5F3A data protection, 7C
broker, 5C deductible, 2G7D
Broker Insurance Document (BID), 8D7 delay in start-up (DSU) insurance, 3B2A
FCA supervision and regulation of, 8B5 delegated authority, 8C3
Lloyd’s, 8B3 duty of disclosure
retail, 8B4 at inception, 2D8
role in the claims process, 8E continuing requirement, 2D8
role in the placing process, 8D legal position for consumers, 2D1B
schemes and delegated authority, 8C3 legal position for non-consumers, 2D1C
services provided by, 8C limitation of an insurer’s right to, 2D9
wholesale, 8B4 on alteration, 2D8
builder’s risk insurance, 3A1A on renewal, 2D8
Building Research Establishment (BRE), 1B1C duty of fair presentation
bureau leader, 9C4 broker, 2D3
business interruption insurance, 3B2 compulsory insurances, 2D6
contracting out, 2D5
insurer’s duty of disclosure, 2D7
C original placement, 2D4
cancellation rights, 2E remedies, 2D4
insurer’s rights, 2E1 variation, 2D4
policyholder’s rights, 2E2
xvi EP2/October 2022 London Market insurance essentials (EPA)
E indemnity (continued)
buildings: basic cover, 2G5B
employers’ liability insurance, 1I1 cash, 2G3A
environmental, social and governance (ESG), first loss policies, 2G6B
6B8 for farming stock, 2G5F
equitable premiums, 1F2 for household goods, 2G5E
Equitas, 5A1C in liability insurance, 2G5G
estoppel, 2D9 in marine insurance, 2G5A
European Federation of Insurance in property insurance, 2G5B
Intermediaries (BIPAR), 9C2 limiting factors, 2G7
excess, 2G7D new for old cover, 2G6C
extortion insurance, 3B8 reinstatement, 2G3D
conditions, 2G5B
Day One reinstatement, 2G5B
F memorandum, 2G5B
facultative reinsurance, 3D7 repair, 2G3B
fair treatment of customers, 6B5 replacement, 2G3C
fidelity guarantee insurance, 3B1B stock, 2G5D
financial Institute of London Underwriters (ILU), 5F2
crime, 7D5 insurable
Financial Conduct Authority (FCA), 5A1, 6A, interest, 1E2, 2C
6B, 6B2, 6B3, 6B5, 7D5, 8B1 common, 2H3
anti-money laundering guidance, 7D creation of, 2C2
authorisation of new brokers, 8B1 modified by, 2C2
authorisation of new insurers, 6E risk, 1E
monitoring, 6E2 insurance cycle
Principles for Businesses (PRIN), 6B4 Insurance: Conduct of Business Requirements
Senior Management Arrangements, Systems (ICOBS), 2D1B
and Controls (SYSC), 6B6 intellectual property insurance, 3B9
threshold conditions, 6B1B International Underwriting Association of
winding-up, 6E3 London (IUA), 5F2
For reference only

Financial Ombudsman Service (FOS), 6F Invisible exports, 1H
Financial Policy Committee (FPC), 6A
financial risks, 1D1 J
Financial Services Compensation Scheme
(FSCS), 6F jeweller’s block insurance, 3A3C
fine art insurance, 3A3E Joint Money Laundering Steering Group
Fire Protection Association, 1B1C (JMLSG), 7D5
first loss policies, 2G6B
fixed portfolio firms, 6B2D
flexible portfolio firms, 6B2D
K
fortuitous event, 1E1 kidnap and ransom insurance, 3B7
franchise, 2G7D
frequency and severity, 1C2
functions of insurance, 1H L
fundamental risks, 1D3
law of large numbers, 1F1
leader
G bureau, 9C4
overall, 9C4
glass insurance, 3B1A slip, 9C4
good faith, 2D1 liability insurance
principle of, 2D1A aviation, 3C2, 3C4
goods in transit insurance, 3A3H employers’, 3B3
general, 3B3
H indemnity for, 2G4B, 2G5G
marine, 3A
hazard, 1C3 motor, 3B3
moral, 1C3A products, 3B3
physical, 1C3A professional, 1I5, 3B3
homogeneous exposures, 1E4 public, 1I3, 1I4, 2D8, 3B3
hull and yacht insurance, 3A1 LIIBA, 5F3C
livestock insurance, 3B4
Lloyd’s, 5A
I broker, 8B3
indemnity, 2G Byelaws, 6D2
agreed value policies, 2G6A capital, 5A1C
application of, 2G4 Codes of Practice, 6D2
benefit policies, 2G2, 2I4B consultative document on conduct risk, 6B5
Corporation of, 5A1
xvii
Lloyd’s (continued) mutuals, 3D6, 5B5

Council of, 5A1
Explanatory Notes, 6D2
managing agent, 5A1B
N
Market Association (LMA), 5F1 National Crime Agency (NCA), 7D3, 7D5
members, 5A1C net amount, 5G1
members’ agents, 5A1D new for old cover, 2G6C
Names, 5A1C non-contribution clause, 2H4
syndicates, 5A1A non-financial risks, 1D1
Lloyd’s Market Association (LMA), 5F1 non-proportional, 3D7
London and International Insurance Brokers’
Association (LIIBA), 5F3C
London Insurance and Reinsurance Market O
Association (LIRMA), 5F2
offer and acceptance, 2A2
London Market, 5G
offshore energy insurance, 3A7
London Market Insurance Brokers’ Committee
onshore energy insurance, 3B1D
(LMBC), 5F3B
open years management, 5A1C
London Market Regional Committee (LMRC),
overall leader, 9C4
5F3B
overseas regulation, 6C
London Premium Advice Notes (LPANs), 8D6
loss of earnings insurance, 3A2
P
M particular risks, 1D3
pecuniary insurances, 3B1B
malicious product tamper insurance, 3B8
peril, 2F2
managing agents, 5A1B
common, 2H3
managing general agents (MGAs), 5D
excepted, 2F2
Managing General Agents Association
excluded, 2F2
(MGAA), 5F4
insured, 2F2
marine insurance, 3A
uninsured, 2F2
builder’s risk, 3A1A
For reference only

unnamed, 2F2
cargo, 3A3A
personal accident insurance, 3B6
cash in transit, 3A3G
physical hazard, 1C3A
delay in start-up (DSU) insurance, 3B2A
political risks insurance (PRI), 3A6
fine art, 3A3E
pooling of risk, 1F
goods in transit, 3A3H
positive customer outcomes, 1J
hull and yacht insurance, 3A1
primary function of insurance, 1H
jeweller’s block, 3A3C
principal and agent, 8A2
liabilities, 3A5
product recall insurance, 3B8
loss of earnings, 3A2
products liability insurance, 3B3
measuring indemnity in, 2G5
professional indemnity insurance, 1I5
offshore energy, 3A7
professional liability insurance, 3B3
political risks, 3A6
property insurance, 3B1
protection and indemnity, 3A5
indemnity in, 2G4A
satellite pre-launch, 3A3F
proportional reinsurance, 3D7
specie, 3A3D
protected disclosures, 6B7
stock throughput, 3A3B
protection and indemnity Insurance (P&I)
war and strikes, 3A4
insurance, 3A5
market agreement, 2H4, 2I3
proximate cause, 2F
market associations, 5F
Prudential Regulation Authority (PRA), 6A,
Market Reform Contract, 2D9, 5G1, 8D2
6B1A, 6B3, 6B4, 6D, 6E, 7A
material information
public
duty of disclosure of, 2D2, 2D3
liability insurance, 1I3, 1I4, 2D8, 3B3
members’ agents, 5A1D
policy, 1E3
money
pure risks, 1D2
insurance, 3B1B
laundering, 7D
client verification, 7D7 R
FCA rules and guidance, 7D5
legislation, 7D3 rateable proportion, 2H4
Money Laundering Reporting Officer Reconstruction and Renewal (R&R), 5A1C
(MLRO), 7D5 regulation
offences, 7D3 of brokers, 8B
regulations, 7D4 of insurers
sanctions, 7D3 regulatory processes, systems and controls
Money Laundering Reporting Officer (MLRO), reinsurance
6B6 buyers of, 3D6
moral hazard, 1C3A Council of Lloyd's, 6D1A
motor insurance, 1I2, 2D6, 3B3 Explanatory Notes, 6D2
xviii EP2/October 2022 London Market insurance essentials (EPA)
reinsurance (continued) theft insurance, 3B1A

facultative, 3D7 treaty reinsurance, 3D7
governance, 6D
non-proportional, 3D7
proportional, 3D7
U
regulations, 6D2 uncertainty, 1C1
requirements, 6D2 underwriter
sellers of, 3D5 following market, 9C2
to close, 5A1C functions of, 9B
treaty, 3D7 lead, 9C
retrocedant, 3D7 slip leader, 9C4
retrocession, 3D7 uninsurable risks, 1E2
retrocessionaire, 3D7 Unique Market Reference (UMR), 8D6
risk, 1A
analysis, 1B1B
attitude to, 1A4 W
averse, 1A4
war and strikes insurance, 3A4
categories of, 1D, 1D1, 1D2, 1D3
whistle-blowing, 6B7
components of, 1C
control, 1B1C
definition of, 1A2 X
identification, 1B1A
insurable and uninsurable, 1E2 Xchanging Ins-sure Services (XIS), 8D6
level of, 1C2
management, 1A1, 1B, 1B1
perception of, 1A1
pooling of, 1F
seeking, 1A4
transfer mechanism, 1A2
uncertainty and, 1C1
For reference only

S
salvage, 2I3
sanctions, 7B
sanctions clauses, 7B5
satellite pre-launch insurance, 3A3F
secondary functions of insurance, 1H
service
company, 5B5
severity, 1C2
slip, 2D9, 5G1
leader, 9C4
Solvency II, 7A4
speculative risks, 1D2
stock throughput insurance, 3A3B
subject-matter
common, 2H3
of contract, 2C1A
of insurance, 2C1A
subrogation, 2I
precluded rights, 2I4
waiver, 2I4C
subscription market, 4B1, 5G, 9C
role of the broker in placing a risk, 8D
sum insured, 2H4
supply and demand, 4A
equilibrium in, 4A5
in the insurance marketplace, 4B
pricing impact on, 4A4
syndicates, 5A1A
T
termination of insurance contracts, 2E
cancellation, 2E1
fulfilment, 2E3A
voidable, 2E3B
terms of business agreements (TOBAs), 8A3A

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London Market

For reference only

Updates and amendments

© The Chartered Insurance Institute 2022

For reference only

Using this study text

Activities: reinforce learning through Key points: act as a memory jogger at

For reference only

Examples: provide practical illustrations Sources/quotations: cast further light

London Market insurance

Summary of learning outcomes Number of questions

1. Understand basic terminology used within the general insurance market 6

2. Understand the fundamental principles 10

3. Understand the main classes of insurance written in the London Market 4

4. Understand the insurance cycle 1

5. Understand reinsurance within the insurance market 3

6. Understand the structure of the 5

For reference only

8. Understand the importance of appropriate systems and controls 2

9. Understand data protection and money laundering legislation and requirements 2

10. Understand the broker’s role in the 4

Published October 2022

For reference only

7. Understand the London Market regulatory

Published October 2022 2 of 3

Reading list Exam technique/study skills

CII study texts

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Published October 2022 3 of 3

For reference only

Syllabus learning outcome Study text chapter

For reference only

For reference only

2: Basic insurance legal principles and terminology

For reference only

3: Main classes of business written in the London Market

4: The insurance cycle

5: Structure of the London Market

6: Legal and regulatory environment

7: Regulatory processes, systems and controls

For reference only

For reference only

Financial risks Fortuitous event Frequency Fundamental risks

A Concept of risk and risk transfer

For reference only

For reference only

A3 Other meanings of the term ‘risk’

For reference only

Risk management is important for a number of reasons:

It reduces the It gives shareholders It provides a

B1 Function of risk management

For reference only

B1C Risk control

For reference only

financial controls such

For reference only

uncertainty level of risk peril and hazard

For reference only

Figure 1.1: The relationship between severity and frequency

Low frequency and high severity