By Claire West

UK companies are exposing themselves to significant and unnecessary losses due to serious flaws in the way their corporate insurance policies are arranged.

This is according to a new study of commercial risk carried out by the specialist research firm Mactavish, in association with PwC, which reveals serious deficiencies in how corporate insurance is arranged and the role of boards in governing those arrangements. This is leaving companies vulnerable in the event of a large loss and subsequent dispute with their insurer.

The report, based on consultations with over 600 UK companies, more than 100 insurers and brokers and detailed case analysis, paints an alarming picture of inadequate disclosure, widespread ignorance of a very challenging insurance law framework, managerial failure to gather relevant information, deeply uncertain policies and a lack of understanding of how large claims are processed.

Bruce Hepburn, chief executive officer of Mactavish, said:

“The deficiencies the report reveals in how insurance is arranged are disturbing. What we see today is a system that has prioritised low transaction costs above reliable insurance policies. This approach is not fit for purpose for the environment we are now moving into. UK businesses, especially medium-sized companies, are putting themselves unnecessarily at risk and in today’s economy are far more exposed if a major insurance policy fails to pay out. Customers, brokers and insurers must all start to invest adequate time into securing appropriate insurance.”

The Mactavish findings come at a time when the role of insurance as a financial backstop is especially vital. The recession has left many companies taking on more risk to protect returns and boards are under increasing pressure to demonstrate effective corporate governance. High-profile risk incidents, such as the widespread volcanic ash disruption, arguably happen at all stages in the cycle, but newly constrained balance sheets, tight credit and the vastly altered risk exposures brought about by globalisation and recession represent new and poorly understood threats.

At the same time, the report shows that insurers are taking a much tougher line on claims. It suggests that reform is not only urgent but highly achievable, if insurance buyers, brokers and insurers work together to improve disclosure and the practices used to arrange insurance.

PwC is co-publishing the research, which it views as a vital component of the wider debate on corporate governance and compliance - where insurance is too often ignored.

Richard Sykes, governance, risk & compliance lead at PwC, said:

“Many UK companies are unaware they are facing costly and damaging gaps in their insurance coverage. The risk that an insurance policy won’t pay out is not being recognised by boards. The lack of quality and in-depth information around risk exposure provided by companies to their insurers is currently inadequate and has left many businesses with unreliable and inappropriate cover. Companies need to make more informed decisions about how much risk they should retain or transfer, rather than simply seeking to minimise insurance expenditure. Insurance needs to move up UK companies’ agendas and become a more important part of their wider risk and capital-management plans.”

Achim Bauer, insurance strategy partner at PwC, said:

“While the quality of risk disclosure provided by the corporate sector is inadequate, the insurers are also playing a material role in an ineffective risk transfer process. Many insurers are failing to systematically develop the necessary understanding of their clients’ risk profile to enter into a truly useful relationship, which is based on more tailored and effective risk management. This is leading to a no-win situation for both insurers and companies, creating a misalignment between risks and premiums, higher claims and more disputes. This report represents both a significant challenge and positive for insurers and brokers. At a time of low growth, many insurers are unable to grasp the opportunities that could come from a closer relationship with their customers and deeper understanding of their risks.”

The report sets out seven protocols intended as a blueprint for change that have now been formally endorsed by a range of leading industry players.

Key highlights of the research show that:

87% of insurance buyers do not understand the extent to which the duty of insurance disclosure is their responsibility or the consequences of failing to meet this duty

Two thirds of buyers (65%) at large companies do not review the materials used to arrange their insurance, and almost all have inadequate discussions with insurers and brokers regarding coverage

Claims professionals across all parts of the commercial insurance market are starting to report an increase in questioning of claims by insurers, on top of an expected surge in losses from operational changes made by firms during the recession. The total number of Royal Courts of Justice commercial disputes (excluding bankruptcy proceedings less likely to relate to insurance) jumped by 45% between 2008 and 2009, with some related categories such as professional negligence disputes up over 100%

The quality of disclosure underpinning insurance is at best poor, sometimes shocking. Almost every document used to explain companies’ risks to insurers, out of the hundreds reviewed in the study, contained errors or omissions that could directly lead to a large claim being questioned. For example, one high-tech manufacturer failed to provide its insurer with details about high-risk product end-uses, delicate testing work undertaken for third parties or the use of highly sensitive manufacturing techniques

Widespread evidence of poor communication between the commercial insurance function and operational managers, reliance on undocumented risk information and insufficient contact between buyers and insurers.