Who pays the price of failure?

The impact of the collapse of the Independent Insurance Company last week could be far-reaching. One group that could be indirectly affected is the victims of the Hatfield rail crash. There has been speculation that the Independent insured GNER, the rail company involved in the disaster. If so, any claims are unlikely to be met by their insurance policies and will have to be paid direct by the company.

Similar issues arise in other litigation against companies insured with the Independent. The comfort factor of having an insured opponent has vanished. People must take their chances of recovering legal costs and damages against what are, in effect, uninsured parties.

There are headaches for individual policyholders, too. The half-a-million private policyholders will have got a nasty shock when provisional liquidators were appointed on 17 June.

The wobble began when Michael Bright, the chief executive, resigned on 14 June and share trading was suspended. All eyes are watching what happens next. Events have moved quickly. On 17 June, PricewaterhouseCoopers was appointed provisional liquidator. It is concentrating on valuing and securing assets. No one knows how much is in the kitty or if reinsurance contracts are valid.

PWC envisages that the company will enter a scheme of arrangement under section 425 of the Companies Act allowing business to be run down without a full liquidation. This would severely delay claims settlement. In the meantime, they recommend that customers place cover elsewhere. But luckily, it seems that agreement is likely to be reached with the RSA to assume around half of personal lines business. This may include claims already made. If this plan goes ahead and is successful, there should be seamless cover for the majority of individual policyholders.

The priority for consumers will be finding out if existing claims will be paid and premiums returned. When insurers go into liquidation, financial support is provided by the Policyholders Protection Board. This is an independent, industry-financed body that administers and pays certain classes of claim. If, as with the Independent scenario, there is only provisional liquidation, the PPB chooses whether to become involved. PWC has said that in this case, the PPB has agreed to step in.

The payment criteria are relatively straightforward. Where insurance is compulsory the PPB ensures that claims are met in full. This includes motor insurance, riding schools, employee liability and nuclear installations. Personal injury claims against employers are therefore covered. However, with general insurance it is only required to meet 90 per cent of liabilities to individuals. Accordingly, in motor accidents third party damage is fully covered, but you are responsible for 10 per cent of repair costs to your vehicle.

Jeremy Stuart-Smith QC, an insurance law specialist says that "industry support mechanisms will largely protect the man in the street. However the Independent's great strength was its vigorous penetration of the commercial market where there is no similar safety net." Corporate policyholders are at a disadvantage, because their "non- compulsory claims" and demands for returned premiums are not met by the PPB. Private customers receive 90 per cent refunds of premium, subject to no claims. Businesses receive no refund.

One Lloyd's broker, reluctant to be named, told me that his company had transferred clients to fresh insurers within 48 hours. They predicted that the Independent's disintegration could have knock-on effects on brokers carrying a large portfolio of business with this insurer. Having put all their eggs in one insurance basket they may encounter difficulties in matching terms elsewhere.

Another non-Lloyd's broker, Ward Evans, which had not transacted business with the downed insurer, also responded proactively. Their initiatives included an e-mail "newsflash" alerting clients to possible ramifications of the crisis. Alex Dawson, the managing director, commented that the insurance market now has a duty to help policyholders refocus business quickly. He is particularly concerned about loss of public confidence in the industry.

Mr Stuart-Smith says the impact of the Independent's failure was greater for being unexpected. No one knows if it was precipitated by decimation of the share price, poor management, lack of business or inadequate reserving levels. "It would be worrying," he says, "if the position had been allowed to deteriorate to such an extent that there was no substance left for claims."

Although it was a relative newcomer, the Independent's demise took the market unawares. In late 1999 the company was voted Best Insurer Overall at the Insurance Broker Industry Awards, an accolade it had been accorded six times since opening its doors in 1987.

The post-mortem examination is keenly awaited. One contributory factor is said to have been the incidence of no-win, no-fee claims. This month's decision in Callery v Gray, in which the court held that premiums are recoverable if cases settle pre-issue, can only increase the insurers' burden. Whatever happens, there will be a concertina effect stretching beyond policyholders and Independent employees who exercised share options or lost jobs. Indirectly, the insurance industry underwrites the PPB's expense. As Mr Dawson says, "it is sad for industry when one of the shooting stars is extinguished."