Key Coverage Options under Employment Practices Liability Policies

Stand-Alone or Combined Policy?

Before purchasing a stand-alone EPLI policy, consider whether obtaining coverage for this exposure by instead buying an EPL coverage endorsement to the company's D&O policy is a better alternative. Among the advantages of this approach include: (1) ease of program administration (obtaining EPL coverage under a D&O form eliminates the need to purchase yet another policy), (2) consistent defense provisions (since EPLI is most often written on a "duty to defend" basis, while D&O policies generally contain "non-duty to defend" language, buying an EPL endorsement to a D&O policy assures consistent defense provisions) and (3) lower cost (D&O insurers generally charge only an additional 10 percent premium for this option; stand-alone EPL is much more costly). On the other hand, the drawbacks of buying EPL endorsements to D&O policies are: (1) potential D&O limit exhaustion by non-D&O claims and (2) lack of coverage breadth compared to stand-alone EPL policies.

Conversely, a stand-alone EPL policy offers these benefits: (1) a broader scope of coverage compared to what is provided under D&O endorsements, (2) the ability to select either "duty to defend" or "non-duty to defend" defense provision options, (3) insulation of an insured's D&O policy limits, and (4) availability of risk management and loss prevention services (which are not offered when buying an EPL coverage endorsement to a D&O form). Downsides of separate EPL policies include: (1) the existence of yet another policy, which increases administrative complexity, and (2) a higher premium cost compared to the price of coverage under a D&O endorsement.

Given these pros and cons, there is no automatically correct choice as to whether stand-alone EPL coverage or a D&O endorsement is preferable. Rather, this is an organization-specific choice, albeit one that should be made consciously, only after carefully analyzing the benefits and pitfalls of each alternative.

Working Layer or Catastrophe Program?

In the current market, insureds have the flexibility to select a wide variety of deductibles/retentions. As is the case with most types of insurance coverage, it is usually best if a firm considers an EPLI policy as a means of financing the "big-hit," single-plaintiff claim or the class-action, multiple-plaintiff claim—rather than using the policy to fund relatively small, run-of-the-mill cases. Of course, the definitions of "working layer" and "catastrophe layer" will vary from firm to firm. For a company with 70 employees and annual sales of $10 million, the catastrophe level may be reached at $100,000 or so. Conversely, for a firm with 2,000 employees and $200 million in sales, $2 million might be considered a comparable level. Of course, many factors other than size will affect the risk retention philosophies of organizations.

An organization that purchases a working layer EPLI policy and suffers a frequency of claims will often find its insurer raising premiums, increasing deductibles, or worse, failing to renew. Accordingly, most insureds should consider selecting a catastrophe-layer deductible and investing the resulting premium savings in loss control measures, such as an in-depth human resources audit. In effect, an insured must intuitively weigh the dollars saved versus expected losses assumed to arrive at the optimal trade-off point when selecting an appropriate level of risk retention under an EPLI policy.

Duty To Defend or Duty To Pay Policy?

EPLI policies are available on a "duty to defend" basis, which gives the insurer the right to select defense counsel and control the defense of a claim. Or, they can be written so that the insurer has "no duty to defend" (also called a "duty to pay" policy). Under the latter, the insured is responsible for managing the defense of all claims, with the insurer obligated only to reimburse the insured for the cost of defense, claim settlements, and judgments.

The advantage of a "no-duty to defend" policy is that it gives the insured the freedom to handle claims as it sees fit, and in the process, establish its own claim handling "reputation." For example, some firms routinely contest all claims, regardless of merit. In contrast, other organizations settle expeditiously all but the most frivolous claims. Given the nature of employment practices liability claims, it is critical for an insured to create its desired "reputation" because the unwarranted settlement of a single case could provide the impression that the company is an "easy mark," thus fueling additional claims.

On the other hand, the advantage of a duty to defend policy is that organizations inexperienced in managing EPL claims may be inefficient or overburdened by the process. These companies could benefit from insurer involvement, even if it means surrendering some degree of control over the settlement process. Ultimately, the decision to buy a "duty to defend" or a "non-duty to defend" policy is a company-specific one that should be made on an informed, carefully considered basis.

Do You Need Third-Party Coverage?

Third-party employment practices liability refers to claims made by non-employees, usually customers, who allege that an employee engaged in wrongful conduct, typically sexual harassment or discrimination. (The most notable third-party liability claims are those alleging discrimination against the national restaurant chain Denny's by a number of minority groups.) In the absence of a specific endorsement for third-party claims, EPLI forms do not cover the exposure. This gap in coverage results because EPLI policies require that covered "wrongful acts" be directed against employees or applicants for employment. Moreover, coverage for third-party employment practices liability claims is precluded under commercial general liability (CGL) policies by means of CG 21 47 (7/98). This standard exclusionary endorsement, which is routinely attached to CGL policies, specifically excludes coverage for "harassment" and "discrimination."

Companies engaged in customer-intensive businesses, such as retail stores, airlines, or car rental companies, are most susceptible to third-party liability claims. In contrast, firms not involved in customer-centered relationships (e.g., manufacturing firms) are not nearly as exposed to such allegations. Third-party liability coverage is generally available by endorsement for additional premium and should be seriously considered by firms that are confronted by these exposures.

What about Punitive Damages Coverage?

A study by the Rand Corporation revealed that punitive damages were awarded in 17 percent of all employment liability verdicts. The mean and median punitive awards in these cases were $2,689,003 and $194,180, respectively. (The study, "Punitive Damages in Financial Injury Verdicts," examined punitive damage awards in 1,294 tort liability verdicts from 1985 to 1994.) In view of these statistics, insureds should consider purchasing coverage for punitive damages within their EPLI programs.

When they were introduced in the early 1990s, EPLI policies almost universally excluded punitive damages. Currently, however, such coverage is readily obtainable. A few insurers provide punitive damages coverage within their regular policy forms. Others cover punitive damages by means of a sublimit (typically 25 to 50 percent of the policy limit, usually for an additional premium of 10 to 15 percent). Finally, some insurers provide punitive damages coverage, subject to regular policy limits, normally for an additional 25 percent premium. Despite such costs, insureds should seriously consider purchasing coverage for punitive damage awards.

Obtain Prior Acts Coverage

Employment practices liability insurance, which is written on a claims-made basis, is a relatively new form of coverage. Accordingly, many firms will be first-time EPLI buyers and therefore will require coverage for claims that may have originated from incidents taking place prior to the inception date of their first policy. However, underwriters are usually reluctant to cover prior acts for first-time buyers. (This is because an insured's sudden desire to obtain coverage could be prompted by its knowledge of an incident that it thinks could lead to a claim.) Nevertheless, prior acts coverage is available in today's EPLI market. Ideally, the policy will be written with no retroactive date (known as "full" prior acts coverage), but if a retroactive date is included, it should be at least 5 years prior to the inception date of the policy. Although first-time EPLI buyers must usually pay additional premium for prior acts coverage, it is generally worth the cost.

Of course, prior acts coverage is also imperative when insureds with existing EPL coverage change insurers. In this instance, prior acts coverage can be achieved if the retroactive date on the new insurer's policy coincides with the inception date of the first EPLI policy purchased by the insured (although ideally, the replacement policy can be written with no retroactive date). And since EPL coverage applications require prospective insureds to warrant that they know of know of no incidents that have the potential to produce future claims, the new insurer should not charge additional premium for granting prior acts coverage.

Conclusion

Although there are other important coverage options to consider when purchasing an EPLI policy, these six are among the most critical. As long as the highly competitive conditions of the current soft market prevail, these alternatives will continue to provide insureds with significant opportunities to decisively improve their EPLI programs.