The security of insurers is a sensitive issue. How far should brokers go to check the financial standing of underwriters? Michael Howard lays down the law

The security of underwriters recommended by brokers is a highly sensitive subject. While many broking houses have security committees to discuss underwriters' solvency, acknowledgement that such a committee exists and details of committee membership are often as secret as the methods employed to vet underwriters' credentials.

This subject is becoming increasingly important, especially since high profile collapses such as that of Independent Insurance. The question is: when placing a client's insurance, to what extent are brokers expected to review an underwriter's financial standing?

There is scant English case law on this issue. The general principle that an insurance broker or other insurance intermediary owes his primary duty to the insured was established in Minett v Forrester [1811]. In this case Lord Mansfield stated:

"[The broker] is an agent of the insured, first in effecting the policy and in everything that is to be done in consequence of it."

The Bolam test
But what duty is owed to an insured? Assistance may be gained from the Bolam test - established by Justice McNair in Bolam v Friern Barnet Hospital Management Committee [1957]. An individual is expect to meet:

"...the standard of the ordinary skilled man exercising and professing to have that special skill."

A broker or other intermediary is therefore required to exercise "reasonable care and skill" when effecting insurance policies. This duty would apply not only when identifying and transferring an insured's risk to underwriters, but also in ensuring that an underwriter will be in the financial position to pay any claims made throughout the duration of the policy. This raises a further question: how much financial investigation should the broker do?

Here the difficulty lies. The "reasonable broker" standard applied by the courts is difficult to predict and, I believe, likely to vary. Consider a multinational broking house with billion-dollar revenues compared to a regional or even a high street broker. Clearly the resources employed by the multinational to check an underwriter's security should be greater than those of the high street broker, and it would therefore be reasonable to expect a proportionately higher standard of financial analysis.

Following Osman v J Ralph Moss [1970], all that can be determined is that where the broker knows an underwriter to be in financial difficulties, he is negligent if he places insurance with that company. In this case the insured was recommended a motor policy by the defendant brokers, underwritten by an insurance company in financial difficulties. Within three months of policy issuance, the insurer was subject to a compulsory winding-up order and the policy subsequently proved worthless.

What then amounts to knowledge of an underwriter's financial difficulties?

The Osman case was clear; there was evidence of a number of press articles written about the company's difficulties and the court had little difficulty in finding that knowledge was present. An Australian case extends this duty to include reviewing and importantly, understanding financial documents.

In Lewis v Tressider Andrews Associates [1987] the broker recommended a new insurance company to an insured after having requested and received its financial details. Properly understood, the financial details should have raised suspicions that the insurer was not reliable. Although the broker claimed he had not understood the nature of the documents, the court held that the least he should have done was ask for advice from his own accountant or auditor, who would have understood the documents. The court found the broker liable when the policy proved of no value.

The duty to advise of an underwriter's evolving financial position is a continuing one. Subsequent to inception, the placing broker in Lewis v Tressider received additional information, casting further doubt on the reliability and solvency of the underwriter he had recommended and bound cover with. The court held that the broker should have passed this new information to his client, even when personally satisfied of the insurer's financial credentials, and was negligent in not doing so.

Rumours and ratings
What is clear is that brokers should consider information available to the public, including company accounts and presumably the plethora of information available on the internet. Rating agencies such as Standard & Poor's and AM Best can also provide useful intelligence, although these agencies only use information obtained from the public domain.

Consider then whether brokers should also consider information from less certain sources, for example, market rumour? In "The Zephyr" (1985) Justice Hobhouse stated that a broker "must make use of his knowledge of the market and use appropriate skill". This could include market gossip.

This issue was considered in Lewis v Tressider. The court thought that the broker should have considered and acted upon market rumour if it was from a source directly involved in the transaction. Much would depend on the evidence before the court - a market expert may be required to establish whether any specific rumour was common knowledge and sufficiently reliable to have been considered.

To conclude, it is necessary that brokers actively and continually analyse solvency information from all sources concerning the underwriters they use and recommend. It is up to them to make their own decision as, after all, it is the broker's risk that its recommendation meets the requirements of the Bolam test.

Question 1
Under the case of Minett v Forrester (1811), to whom does a broker owe primary duty?

a .The insurer
b .Him/herself
c .The insured
d .All three.

Question 2
What significance does the `Bolam Test' have in relation to the duties of a broker?aIt defines the nature of the broker's dutybIt defines the nature of the courts' duties cIt describes the sort of thing that a broker is expected to know.

Question 3
Does a broker have any duty to pass on knowledge of an insurer's evolving financial situation?

a. Yes, but only if he/she thinks it is really important
b. Yes, a continuous one
c. No, it is up to the insured to read the press.

Michael Howard is a solicitor and chartered insurance practitioner at Kennedys. He can be contacted on 020 7638 3688.

CPD articles are edited by RW Associates, specialists in training, competence and compliance.