Environmental, social and governance (ESG) factors are now high on the agenda for all businesses, shaping corporate strategy and reporting. ESG has moved beyond a “soft” set of notional aspirations, initially aligned to corporate social responsibility, to become a distinct driver of corporate board and shareholder behaviours, as well as influencing supplier and buyer decision making.
ESG factors include: (i) environmental (such as extreme weather, GHG, or greenhouse gas, emissions and carbonization, waste management, rights of indigenous communities); (ii) social (workplace culture, employee relations, modern slavery); and (iii) governance (broad structures, shareholders’ rights and relationships, audit arrangements and solvency). There is a growing body of legislation and regulation in both developed and emerging economies, the aim of which is to give teeth to the broader objectives of ESG.
“In terms of exposure to professional indemnity claims relating to ESG, part of the challenge for insurance brokers is to determine what ESG information is relevant to the risk being placed, the level of detail required to satisfy the duty to disclose, and how best to communicate relevant information both to insurers and the insured,” says Diego Assef, head of global practice group for professional indemnity claims at Allianz Global Corporate & Specialty (AGCS).
“The level of risk for brokers will vary, depending on the market and industries they support. An example of potentially higher risk is placing D&O [directors and officers] insurance in the energy and power sector, which is becoming more heavily regulated in terms of increasing requirements for disclosure on matters relating to climate change.”
What are brokers’ duties?
Across jurisdictions, particularly those governed by common law principles, a broker has a duty that equates in principle to the requirement in England and Wales to exercise “reasonable skill and care”. In the UK, this is implied by common law and by statute. A broker must meet the standard of a member of the profession in the same market; an extraordinary degree of skill is not required.
The general rule is that the broker is an agent of the insured, meaning that if the insured is unable to recover under an insurance policy, the broker can potentially face a claim for negligence and breach of duty. Other requirements, including regulatory duties, are addressed below.
The vast majority of US states (including major jurisdictions such as New York, California, Illinois, Florida, and Texas) apply a “reasonable skill” or “reasonable diligence” standard in evaluating an insurance broker’s conduct. Generally, that standard can be higher if there is a contractual arrangement between the insured and the broker, in which case the standard imposed by the contract will govern.
Additionally, some states, such as New Jersey and Idaho, treat the insurance broker as a “fiduciary” of the insured and hold it to a higher standard than other states.
A case in California has potentially expanded liability against insurance brokers who hold themselves out as specialised insurance brokers. In the case of Murray v. UPS Capital Insurance Agency, Inc. (2020) 54 Cal.App.5th 628, the Court of Appeal held there was a triable issue of fact – that is, a dispute capable of being resolved through legal trial – “whether UPS Capital was holding itself out as having expertise in a specialised area of insurance, and therefore, assumed a heightened duty of care”. Ultimately, the issue of whether the insurance broker assumed a heightened duty of care will (in US cases) be left to a jury to decide.
In many jurisdictions, there is statutory governance in addition to tortious and/or contractual obligations. For brokers in Germany, the Insurance Contract Act is of key significance, together with the broker/client contract.
In England and Wales, the Insurance Act 2015 came into effect in August 2015. It applies to most non-consumer insurance contracts, imposing on the insured a duty of fair presentation of the risk to insurers before a contract is finalised. In turn, therefore, a broker has a duty of care to advise the insured of the duty of fair presentation and, in particular, the obligation to disclose material facts. In practical terms, a broker will need to help insureds understand what must be disclosed to insurers and ensure that details and information relevant to the risk are presented clearly.
In many countries, there is an additional layer of mandatory regulation that applies to brokers. In Australia, (in addition to common law and statutory duties), members of the National Insurance Brokers Association are governed by the Insurance Brokers Code of Practice. Brokers owe a duty to use reasonable skill, care and judgement in accordance with established professional standards.
In England and Wales, the regulatory body for insurance brokers is the Financial Conduct Authority (the FCA). There are detailed rules setting out required standards, including those set out in the FCA’s Principles for Business Sourcebook. Key principles include treating customers fairly and communicating information in a way that is appropriate to that client, being clear, fair and not misleading. Advice given should be suitable for the customer’s needs and situation. Firms must manage conflicts of interest fairly, both between themselves and their customers, and between a customer and another client.
Most insurance brokers are additionally bound by the ICOBS rules, which also form part of the FCA Handbook – Insurance Conduct of Business Sourcebook. Important requirements affecting brokers are summarised below:
- Clear communications to customers that are not misleading, including information relating to fees and commissions.
- Brokers must act honestly, fairly, and professionally in accordance with the best interests of their customers.
- The advice provided must be suitable for the customer. Brokers must only propose insurance that is consistent with the customer’s demands and needs, and clearly explain any exclusions, limitations etc.
- Brokers must explain to a commercial insured:
- the duty to disclose all circumstances that are material to a policy;
- what needs to be disclosed; and
- the consequences of any failure to disclose.
- Brokers must explain to a consumer the requirement to take reasonable care not to make a misrepresentation, and the possible consequences of careless responses.
- Brokers must ask the customer clear and specific questions about relevant information.
- Brokers must provide customers with appropriate and comprehensible information about a policy in good time to facilitate informed decisions about the proposal(s). This is known as the “appropriate information rule” and it applies pre-contract, post-contract, to mid-term changes and at renewals.
- In claims handling, brokers must appropriately disclose and manage any conflicts of interest.
In South Africa, the relevant duties of brokers are specified in the Financial Advisory and Intermediary Services Act (FAIS Act) General Code of Conduct and can be summarized as follows:
To act in good faith: the broker should perform his or her mandate in the interest of the insured. The broker must be honest with the insured and shall not make a secret profit.
To advise the client properly: in terms of the common law, a broker is required to properly advise an insured as to the suitability of the product recommended by the broker. This involves a degree of care and skill that the reasonable broker (not the reasonable person) would have exercised.
To obtain insurance coverage: a broker is required to evaluate the insurance needs of the insured and base his or her recommendation on such evaluation. The broker only has to make a reasonable attempt to obtain cover for his or her client. If the cover is obtained, the broker must advise the insured of the terms of the cover. Should it not be possible for the broker to obtain appropriate cover, the client must likewise be notified.
To explain the meaning of the policy: the FAIS General Code requires a broker to provide a reasonable and appropriate general explanation of the nature and material terms of the relevant contract or transaction to the prospective insured, and to disclose all information that would enable the prospective insured to make an informed decision regarding the cover openly and straightforwardly manner and to provide the prospective insured with material contractual information.
What are the risks for brokers relating to ESG?
Brokers need to be aware of the professional indemnity risks relating to ESG. These include:
- Not fully advising the insured as to what they need to disclose in relation to ESG.
- Not asking the insured clear and specific questions about information relevant to the cover required in terms of ESG – generic or standardised questions may not be sufficient to discharge this duty.
- Not giving suitable advice due to insufficient knowledge of insured’s business and/or insufficient knowledge of ESG.
- Not recommending cover that fits with the insured’s needs and demands for ESG cover.
- Failing to explain accurately/fully any limitations on cover in relation to ESG.
- Failing to provide appropriate information about a policy in good time and in a comprehensible form so the insured can make informed decisions about the proposed arrangements – in England and Wales, this is known as the “appropriate information rule”.
Here are some specific examples of how claims might arise in the context of ESG.
- Ambiguous instructions
Brokers may be in breach of duty if they receive instructions which are obviously ambiguous, and they do not seek further clarification from the insured. A broker may be in breach of duty if, having received instructions to include cover for ESG that are unclear in terms of the risk level of the insured, the broker fails to seek clarification.
- Cover not meeting requirements of insured
Brokers will usually have a duty to obtain cover which clearly meets the insured’s requirements. A broker may be at risk if they gloss over the issue of ESG and therefore inadvertently obtain insurance that does not clearly meet the insured’s requirements for cover on ESG. This risk may be heightened at renewal, if wordings around ESG have evolved and/or the cover available in the market has changed.
Another aspect to consider will be whether or not the insured requires a specialist insurance solution relating to ESG – this might apply to an energy company transitioning from fossil fuels to renewable power sources. Brokers need to ensure they know the type of specialist cover that is available in the market and when this might be appropriate.
- Lack of knowledge of ESG
Brokers will need to understand the needs and demands of the insured, to investigate the availability of cover in the market in relation to any particular risk and to represent accurately information about the risk to insurers. Brokers face a steep learning curve in relation to ESG. To be able to ask the insured the “right” questions and present the risk to insurers accurately, they need to have a good understanding of ESG and how it impacts the insured. If they do not fully understand the implications of ESG and the cover available, brokers may be in breach of duty.
- Policy wording
Brokers’ duties are likely to extend to drafting the contract (insurance policy) with reasonable clarity and may not be able to rely on a particular clause having been drafted by a lawyer. Policy wording relating to ESG cover is likely to evolve quickly over the next few years and brokers will need to ensure they keep up to speed on this to avoid the risk of a claim.
- Ensuring the insured understands key policy conditions
A broker will need to ensure that the insured understands any key conditions under the policy. In terms of the G in ESG (governance), this could be, for example, a condition in relation to the IT security to be maintained by the insured. Where a cyber breach or attack then occurs, the broker may be at risk if the appropriate advice was not given to the insured on that condition at inception and/or renewal.
Ensuring that the insured understands the parameters of cover is key – for example, whether it is “claims made” (such as professional indemnity insurance) or “occurrence based” (for example, cover for general liability).
A broker will need to ensure that adequate cover is obtained in relation to ESG risks. If, in fact, the insured turns out to be underinsured for ESG risks, the broker may be in breach of duty. Part of the challenge for brokers is to know the insured – for example (in relation to the social and governance in ESG), placing professional indemnity insurance for a design and build contractor: are there particular risks arising from the insured’s supply chain relating to modern slavery?
It should be noted that regulators are becoming more prescriptive about brokers ensuring the companies they deal with are ESG compliant – so, in the energy market, for example, what is the insured’s approach to fossil fuel?
A further example relates to greenwashing risks – for example, if the broker presents an insurance product as “green” and, in fact, it is not, thereby leaving the insured potentially exposed to a criticism of not adhering to the sustainable principles it claims to support. This could lead to a possible claim for breach of duty against the broker.
The insurer’s view: professional indemnity for brokers
Insurers will be increasingly aware of ESG matters when underwriting the risks facing brokers, taking note of the changing landscape in the market. Underwriting practices will be adapted to an evolving ESG regulatory environment and ESG-related practice.
Insurers’ assessment of the risk will include investigation of the services the broker provides and to whom, internal governance (such as ESG training) and claims history.
Brokers are on unfamiliar ground
Some brokers may initially find themselves in unfamiliar territory in terms of placing ESG risks, as the market evolves. “There are some similarities with the Covid-19 pandemic in terms of emerging ‘new’ risks,” says Assef. “There may be disputes over policy coverage as to whether pre-existing cover extends to any particular ESG risk. To what extent can it be argued that during this transitional phase – which is to say, the emergence and increasing prominence of ESG – it was foreseeable that such claims might arise and therefore cover was required?
“This may result in negligence claims against brokers for alleged failure to ensure appropriate cover was provided,” Assef continues. “Such disputes, however, are not always visible and so may prove difficult to track – in Hong Kong and Singapore, for example, it is rare for negligence claims brought against brokers to come before the courts, and such disputes, if they arise, tend to be resolved informally without recourse to litigation.”
What steps can be taken to reduce brokers’ risk?
- Ensure that brokers are fully trained on ESG issues.
- Ensure up-to-date market information is available to brokers, including what ESG cover is available in the market and current wording.
- Put key communications with the insured in writing and keep notes of any oral advice.
- Ensure that the insured’s instructions are clarified on cover for ESG risks if necessary.
- Clear and specific questions about information relevant to the cover required in terms of ESG need to be asked of the insured – generic or standardized questions will not always be sufficient to discharge this duty.
A broker holding themselves out as an ESG expert may be at risk if their client finds themselves without coverage for a claim/suit. “When a client is without coverage, the downstream effect is to possibly look to other avenues to circumvent the adverse decision, meaning focusing on their broker for recovery,” says Gena Hendricks, claims expert within the global practice group for professional indemnity claims and quality assurance specialist at AGCS.
“Defending a broker malpractice suit can be protracted and costly when a client alleges the broker held themselves out as an expert and the client relied on their expertise in securing coverage. Depending on the jurisdiction, lawyer fees can reach thousands of dollars, cause a lot of uncertainty and unnecessary administration work to brokers, as well throwing shade on their market reputation and overall expertise,” Hendricks concludes.
A broker could consider using outside ESG experts to transfer the risk or even partner with an insurer that has strong ESG underwriting expertise, in order to improve their ESG strategy and be more prepared to better advise on the evolving risks arising out of the ESG arena.
Keeping an eye on the growing importance of this subject and its development is paramount to everyone working in the insurance industry and it should be a recurring topic on everybody’s agenda.