An insurance broker's standard of care – Bridging the insurance knowledge gap, not quite Sherlock Holmes but the broker must follow up obvious gaps and uncertainties

In a recent judgment, the High Court looked at the scope of duty of an insurance broker in circumstances where the claimant/policyholder had insufficient cover following a warehouse fire. The judgment arguably does not break new ground, but serves as a useful reminder that an insurance broker should make sure it fully understands a policyholder's business to be in a position to properly consider relevant insurance, notes of meetings are critical and warnings in generic documents are unlikely to discharge any duty if the insurance broker does not know enough about the business to recommend appropriate cover or is otherwise on notice of risks that it does not look to cater for. The judgment also looks at contributory negligence where the claimant/policyholder did not adequately calculate turnover for the purposes of business interruption cover, finding that the claimant contributed to the underinsurance position it was left in and reducing damages by 20%.

The Facts

The Claimant, Infinity, was an online retailer selling personalised gifts for babies and children.  Given Infinity personalised gifts, once an order was placed it had to collect the goods from storage and then personalise the goods – as a result it needed space in a warehouse for staff to personalise the goods before despatch.  In 2021 it was using a warehouse space owned and operated by a third party.  This included using some of the third party's equipment.  In May 2021 there was a fire at the warehouse meaning that Infinity could not use the warehouse any more – this interrupted its business resulting in lost sales whilst it found alternative premises and fit them out.

Infinity claimed on its insurance but (1) the cover was not enough for the interruption to its business and the cover was reduced as Infinity had under reported its financial position to insurers as a result insurers applied 'average' to the claim meaning it reduced pro rata the indemnity by the proportion of the underinsurance (as Infinity's business interruption was based on forecasted gross profit of £24.9m over 2 years but the actual figure was more like £33m, its insured amount was reduced by 26%) and (2) the costs of fitting out new premises were only partly insured (Infinity had used a third party's equipment previously and so needed new equipment when that became unavailable following the fire).  Infinity brought a claim against their insurance broker given it was left under-insured.

The Allegations and Judgment

Infinity alleged that the insurance broker:

• Failed to provide Infinity with a document describing how to calculate the sum insured and the document provided was misleading, which led Infinity to purchase insufficient cover.
• Should have recommended a different type of business interruption cover – declaration linked cover – and had they done so there would not have been any underinsurance.
• Should have realised that Infinity needed additional cover for fit out costs in the event it needed to change premises.

1. Underinsurance

The insurance broker admitted breach of duty for having provided misleading information in relation to the calculation of insurance cover for business interruption purposes.  In particular, the explanation document provided to Infinity setting out how to calculate cover for business interruption purposes did not match the way in which the calculation was undertaken under the relevant insurance policy.  The insurance policy looked at the difference between turnover and the cost of material for production and discounts received, whereas the insurance broker's explanation document looked at the difference between turnover and expenses which would reduce or disappear entirely, in the event of a stoppage of the business.

Although the insurance broker admitted breach it alleged contributory negligence on the part of Infinity given that the calculation Infinity conducted and on which the business interruption cover was based was incorrect even if Infinity had followed the insurance broker's explanation document – Infinity had under represented its position anyway.

Before turning to consider contributory negligence the judgment at paragraphs 78 and 79 sets out a useful summary of the court's to approach claims against insurance brokers and in particular assessing the standard of care:

"… A major part of the broker's role is to bridge the gap between the client's knowledge and its own.  The ideal client deeply understands its business, its appetite for risk, its capacity to bear loss, and its budget for insurance.  The ideal broker deeply understands the cover available in the market, its terms and cost, and how to obtain it.  The broker must learn enough about the client's needs and business to make sensible recommendations.  It must tell the client enough about insurance to enable an informed decision (not necessarily one the broker agrees with) and an effective purchase.  What is required to do that with reasonable care varies.  A multinational corporation with a multi-billion-dollar turnover and a dedicated risk-management department needs different treatment than an individual buying cover for a startup business.  And bridging the cap does not mean eliminating it.  The client will always know more than the broker about its business.  The broker will always know more than the client about insurance…"

The insurance broker's case on contributory negligence was that the guidance document it provided to Infinity included the warning "… In the event that the Gross Profit sum insured is not calculated correctly, there is likely to be underinsurance and average would apply to the settlement of ANY claim".  Infinity confirmed that they had read and understood the warning, but did not understand "average" and did not ask the insurance broker to explain it.  Infinity said that they assumed the limit indemnity would be paid, such that so long as the loss was below the limit of indemnity it would be paid in full.  So Infinity thought that underinsurance was only problematic if a loss exceeded the insured sum. 

The Court concluded that given the way Infinity calculated its turnover for the purposes of business interruption cover meant that it carried some fault – "… There was, in the end, two mistakes [in the calculation].  One mistake was that the 2020 gross profit figure was too low.  That mistake, which was due to [the insurance broker's] breach of duty, had not been made, Infinity would have had full insurance… The second mistake was that no real growth forecast had been made, but the figure inflated by an arbitrary 10%.  If reasonable forecasts had been used instead, Infinity would have had full insurance, even starting from the wrong gross profit figure.  Each mistake was a sufficient cause of the loss: avoiding either would have mitigated or eliminated the effect of the other…".  Having found Infinity also at fault, the Court applied a reduction for contributory negligence at 20% with the Court stating that "… I would have made a higher reduction of 40 percent; but my assessment reflects the fact that the [insurance broker] was negligent in multiple respects, and that some of the negligence consisted of a failure to recommend a type of policy which is in part designed for the very purpose of reducing the risk that careless errors with figures will reduce cover…"..

2. Type of cover

On the allegation that the insurance broker should have recommended declaration linked cover (where the level of cover is linked to turnover and the premium increases as necessary so the policyholder does not have to forecast its turnover), the parties' experts agreed that this cover should have been recommended (given, the uncertainty with respect to turnover during Covid-19 in particular) but the insurance broker argued that even if it had recommended declaration linked cover, Infinity would have opted for cover based on turnover to minimise premium. 

The Court rejected that point on the basis that Infinity did not make an informed decision – in particular, the insurance broker did not make sure that Infinity understood the implications of underinsurance or the difficulty and importance of estimating the sum insured, or that the price Infinity would pay for certainty about the premium was uncertainty about recovery if it suffered a loss and had to make a claim.  Further, although Infinity had expressed a preference for gross profit based business interruption cover, the Court found that a reasonable broker would check it remained a genuine and an informed preference at renewal especially as circumstances changed and "… a reasonable broker will be alert to changes of circumstance, and will at least want to make sure that important decisions (especially if they involve doing something that the broker would not recommend) continue to operate…".  The Court also attached no weight to the fact that Infinity had read about declaration linked cover in a business interruption guidance document and not asked about it finding "… An insured cannot be expected to follow breadcrumbs scattered through the documents to discover about suitable insurance products that the broker could, and should, simply have recommended…".

3. Fit out costs

With respect to fit out costs, the Court first considered whether the insurance broker should have been on notice of the fact that Infinity used another party's equipment in the warehouse, and so if that warehouse was unavailable due to an event like a fire, that it would need cover for new equipment.  The Court found that "… what is required is enough detail to identify the main risks that the client faces which might require insurance, usually an accurate roadmap… the dividing line between the reasonably curious and the impertinently sleuth like is hard to put into words.  The broker is not expected to second-guess or audit the information it is given. But it is necessary to follow up reasonably obvious gaps and uncertainties…".  

Here the Court found that the insurance broker was aware that the third party's warehouse was critical to Infinity's business and if that was not always apparent it became apparent following a cyber incident in 2019, the insurance broker knew that the third party owned the warehouse apart from some machinery and computer equipment that Infinity insured and knew that Infinity relied on the third party's staff and systems to pick and despatch goods.  The Court also found that the insurance broker did not know whether Infinity would find an alternative warehouse quickly or if its arrangement with the third party was difficult to replicate. However, the main reason the insurance broker did not know is it did not ask the question, with the Court finding that "… The possibility that the warehouse might become unavailable was not an obscure detail that needed to be ferreted out.  It was an obvious risk...".

Analysis

The decision arguably does not break new ground, but it provides a useful reminder of the court's approach to the scope of an insurance broker's duty including – (1) its job to bridge the gap between the client's knowledge and its own, (2) the need to ensure that "important decisions" are checked again at renewal, (3) to make sure that information is clear to policyholders so they make informed decisions and warnings are not buried in documents and (5) asking sufficient questions about the business to identify the main risks and follow up obvious gaps and uncertainties.  

Perhaps the more interesting part of the decision is the analysis of contributory negligence – the court found that (1) the insurance broker incorrectly advised the claimant on how to calculate turnover for business interruption purposes and (2) the insurance broker should have recommended a different product whereby the calculation of turnover would not have mattered and the claimant would have had full cover for business interruption.  Despite this the Court reduced quantum by 20% for contributory on the basis that had the claimant calculated its turnover accurately then it would have eliminated the loss (just like the insurance broker could and should have done).  The court's approach to contributory negligence here is something to bear in mind where there are two causes of the same loss and one of them is the fault of the claimant.  It is worth noting that the court could have looked at quantum by reducing it for the additional cost of the claimant (a) having to pay a higher premium for a higher level of cover or (2) having to pay a higher premium for declaration linked cover – these points do not make the decision (if they were argued) but would appear unlikely to have produced the same level of discount as 20% contributory negligence the court applied.

Please click here for the judgment.