What lies beneath? The bane of all wordings.
An increasing number of insurance and reinsurance wordings contain clauses which not only allow a policyholder (or in the case of reinsurance the insurer) to cancel mid-term in the event of insolvency, but also in the event of a ratings downgrade.
There would appear to be no consistency within the market as to the wording of these downgrade clauses and thus to the trigger for activation and the options available. Some require a carrier to be downgraded by up to two rating classes, some one, others have options to allow cancellation if the carrier is merely put on “negative watch”. Some automatically require a return of premiums, others a commutation including crystallisation and settlement of outstanding losses.
The short term implications for a policyholder or an insurer should its protections be cancelled following a downgrade are foreseeable and capable of calculation. The longer term issues such as loss of future business through no longer being acceptable security are likely to have a far greater financial impact.
But what of the market as a whole? If a small number of key insurers/reinsurers suffer downgrades and cancellation clauses are automatically invoked, the financial security of those being protected will be negatively affected and they too may suffer downgrades. A domino affect and market spiral is very easy to envisage which might endanger the structure and security of the market as a whole. In which case the problem becomes a global one for regulators and the FSA.
Which clauses should a policyholder, broker, insurer, reinsured, reinsurer request or accept? Do syndicate and company compliance departments know precisely what is written into their current wordings? Have they considered and calculated the compliance and financial implications of various eventualities?
The devil is in the detail – and in the lack of consistency!