New Issues in the Marketing of Producer Errors and Omissions Insurance

Marketing Features That Suggest Potential Problems

The factors providing cause for an agent to raise questions about his or her liability coverage are: (1) the insurance purports to be a group policy, typically an association of agents; (2) the group is ill defined, has no formal structure, has no constitution and bylaws, has no formally elected set of officers, and never holds a meeting to discuss liability insurance; (3) a master policy is issued to an association or a trust often located in a distant state; (4) an insured receives a certificate of coverage (as in group health insurance) but never sees the master policy; and (5) the group claims to represent the agents of the company for which an agent works as an independent contractor.

Problems of Agent Representation and Control

Insurance brokers often play a major role in setting up an E&O group plan. In the L&D INSURANCE program, a broker acted in concert with the captive agents' insurer to set up and administer the liability insurance program and arranged for a group policy to be issued to a purported risk purchasing group. Although brokers generally represent the interests of an insured, when asked which party his agency represented, without hesitating, the broker declared that his company represented the insurer, L&D INSURANCE. Similarly, L&D's representatives asserted that the company did not represent the insured agents. The agents, of course, have no formal mechanism for representing themselves. The agents further agree in the policy that L&D INSURANCE and the broker-dealer act on behalf of the agents for all purposes, including acceptance of endorsements and cancellation/nonrenewal actions.

The practical effect of the insureds' absence of any role in the program (except paying premiums) is that L&D INSURANCE, the chosen E&O insurer, and the broker are free to act arbitrarily in deciding about what protections the certificate holder agents receive. For example, while it is industry custom and practice and a regulatory requirement to identify all endorsements on the declarations page of a policy, the custom and practice followed by controlling parties in this L&D INSURANCE program deviated substantially from this standard.

To illustrate, the relevant endorsements in the certificate of coverage are listed in the agents' certificate under "Endorsements Effective at Inception: Endorsements 1–5." These endorsements identify only the following:

Investment Advisor Representatives and Associated Persons Endorsement

Cost of Corrections Endorsement

Amendment to Exclusion L. Endorsement

New York Amendatory Endorsement

Class Action Exclusion Endorsement

In actuality, the master policy contains several other endorsements that are not reflected in the certificates of coverage.

Testimony confirmed that master policy endorsements were adopted retroactively and there was no established means of informing certificate holders of the changes. Even worse, some of the changes reduce coverage or, in some other way, work to the detriment of agents without any adjustment in premium. For example, what is commonly known as the "hammer clause" ("Consent to Settle" in the policy) is a good example of how detrimental a secret endorsement process can be for insureds.

The hammer clause appears as endorsement #7 (remember that the declarations page lists only five). It amends the master policy to read:

The Company shall not settle any Claim without the consent of the Insured, which consent shall not be unreasonably withheld. If, however, the Insured refuses to consent to any settlement recommended by the Company and acceptable to the claimant, then the Company's limit of liability under this policy shall be reduced by the amount for which the Claim could have been settled plus all Claim Expenses incurred up to the time the Company made its recommendation. This amount shall not exceed the remainder of the amount of liability.

If the Insured refuses to settle, once the total Claim Expenses equal the amount for which the claim could have been settled plus all Claim Expenses incurred up to the time the Company made its recommendation, the Company shall have the right to withdraw from the further investigation and defense thereof by tendering such investigation or defense to the Insured and the Insured agrees, as a condition of the issuance of this policy, to accept such tender.

The hammer clause endorsement bears a date of adoption more than 3 months after the policy's effective date. In fact, neither this endorsement nor endorsements 1–5 that actually appear in the declarations section had been approved by time of policy issuance.

These endorsements were added to the policy without notification to the insureds, and the controlling parties were unable to identify any method for informing the agent-insureds of endorsements changing policy provisions.

Under this L&D INSURANCE plan, therefore, agents are buying blind when they enroll in or renew their coverages. Moreover, the company from which the agents hold appointments (L&D) is listed as a named insured along with the agents on the declarations page, but the definitions section states that "additional insured" shall mean the insurance company named in the declarations. Elsewhere, the additional insured is given all of the privileges and rights of any insured. Disputes between L&D agents and L&D are excluded, and there is no coverage for "innocent insureds." Coverage for class action lawsuits is excluded by endorsement.

Cancellation Rights

Another example of arbitrariness in plan administration is how certain companies handle cancellation rights. To illustrate, one L&D agent sued his insurer for bad faith claim handling in a case in which he was a defendant. His contract with the company set no production standards and only required that he hold a valid producer's license to qualify for the E&O insurance; nevertheless, after his lawsuit was filed, the company terminated his agent appointment for nonproduction. Since he had to have a contract with the company to maintain his insurance, he lost E&O coverage. In effect, then, the insurer that appointed him to represent it, the insurer that was also both a named insured and an additional insured under his E&O policy, terminated him for asserting his rights under his E&O policy. No provision in the policy enabled a person losing group coverage to buy an individual policy.

This practice is not in conformity with regularly accepted standards of genuine group insurance. For example, a standard feature of group plans is that one facing the same situation should be able to purchase individual coverage upon leaving the group. As the National Association of Insurance Commissioners Model Law on Mass Marketing of Property & Casualty Insurance states:

All mass marketing plans shall provide that upon termination of employment or membership or upon the discontinuance of the mass marketing plan, the insured employee or member may maintain his policy in force for sixty (60) days in the same amount, upon payment of the premium applicable to the class of risk to which he belongs on an individual basis.

Policies May Offer Limited Coverage

As the L&D coverage gaps suggest, agents may be purchasing limited coverage under group policies established with their own appointing company's seal of approval. To further illustrate this point, I cite the following examples from a plan available to DOMESTICA agents through a risk purchasing group. The agents are appointed as captive agents of DOMESTICA, and the policy was secured from a well-known insurer.

The policy is a claims-made and reported policy requiring that a claim be made and reported within the policy period. In a regulatory filing with at least one state, the policy is approved only as a claims-made policy, not a claims-made and reported one.
There is no spousal coverage. This is important because in E&O claims, jointly owned assets may be exposed and an agent's spouse may need a defense.
The policy contains a "hammer clause," similar to the L&D INSURANCE policy. In the simplest terms, this means that, if the insurance company and the plaintiff reach a settlement but the insured rejects it, the insured is responsible for paying defense costs from that point forward and must pay any judgment above the amount the plaintiff and insurer agreed on. (If the insured continues the defense and the final judgment is below the agreed-upon number, there is no corresponding reward for the insured. Prudent insurers might take note, however, because such a scenario is fertile ground for a bad faith claim against the insurer.)
Settlement negotiations between an insurer and its insured in E&O claims are made difficult because insurers may be bargaining over cost while the insured is fighting over his or her reputation. Hammer clause provisions under these conditions can be harsh in effect; consequently, any broker or purchasing group negotiator should show evidence of attempts to delete hammer clauses. Alternatively, if deletion is impossible, attempts could be made to hold the insured responsible for only a percentage of additional costs, not 100 percent. There is no evidence that such negotiations occurred in either the L&D or the DOMESTICA policies.
"Professional services" is undefined in the policy. In contrast, since providing professional services is the principal function of an insurance producer, a detailed description of covered and excluded services is warranted. Failure to accurately and completely describe the services covered may lead to a serious lack of coverage.
The policy limits punitive damage coverage to $5,000. Many jurisdictions allow punitive damages, and demands for punitive damages are common in professional liability litigation. A more generous option for insurance agents is preferable. For example, a "most favorable jurisdiction" provision might be added. This would identify four criteria for choosing a most favorable venue for coverage of punitive damages: where the act giving rise to the claim occurred; the state where the claim is made; the insured's place of incorporation or where it has a principal place of business; or the insurer's domiciliary state or principal place of business.
There is no severability provision in the policy, although such a provision is common in the industry. A severability clause protects interests of innocent insureds who might also be subjects of a claim although they had no knowledge of the improper act and did not participate in it.
There is an exclusion for claims brought by one insured against another insured. This is a group master policy that insures all agents under one policy. This exclusion suggests that, if two insured but legally separate insurance agencies disagree and engage in litigation involving an otherwise covered cause of action, neither is covered.
The term "claim" is undefined, although this is a claims-made-and-reported policy. For example, does "claim" include regulatory proceedings? If not, this is a significant coverage gap.
The definition of "wrongful act" is skeletal at best. Under the policy, "wrongful act" means "any actual or alleged negligent act, error or omission," and the policy definition embraces "personal injury offenses." A more meaningful definition is found in a sample policy appearing on the Independent Insurance Agents and Brokers of Georgia website where "wrongful act," either in singular or plural, means:

1. Any actual or alleged negligent act, error or omission, or negligent misstatement or misleading statement by the Insured in the rendering of or failure to render Professional Services; or

2. Any actual or alleged negligent Personal Injury arising out of the Insured's rendering or failure to render Professional Services. (Bold lettering indicates defined terms.)
This policy also has an arrangement that covers only those acts that fall outside an agent's written authority as established by DOMESTICA. Thus, although disputes between agents and the insurers they represent are common, there is no coverage for that type of dispute in the policy. Nevertheless, DOMESTICA promises that if an insured is sued while acting within his or her scope of authority, DOMESTICA will protect that agent under the same terms and conditions as found in the E&O policy—a policy issued by another company. However, this promise is not in the E&O policy. Further, according to one agent who was the victim of a civil suit for damages, DOMESTICA officials intervened, uttered threats, and told her she had no coverage even though she was not personally involved in the alleged infractions leading to the litigation. DOMESTICA was not the company under which she had E&O coverage, yet DOMESTICA attempted to deny her an opportunity to seek coverage for defense and indemnification. Ultimately, DOMESTICA paid the claim and then subrogated against her. No claim was ever filed with her own E&O insurer.

Conclusion

While the generally held opinion is that access to group markets offers certain advantages to insurance purchasers, there are exceptions, and it is very important that a prospective buyer investigate the nature of the group before committing to buy E&O coverage. No matter whether a person is a life and health or property and casualty producer, keeping up with markets and policies can be a bewildering task.² Yet, failure to strip away the blind spots about the group, to determine how it is governed, to know the degree of transparency of its operations, and to find out whether the insured persons have any influence over the group's governance are key considerations in the purchasing decision. Clearly, some of the groups are run by persons unfamiliar with the field or, in the alternative, by persons with motives that are not necessarily in the best interest of agent/insureds.

My next installment on these issues examines the role of risk purchasing groups, the regulatory standards, and suggestions on possible improvements in the marketing of E&O policies.

¹ See my "Marketing Health Insurance Through 'Trusteed Groups': A Perversion of the Group Insurance Concept," IRMI Commentary, March 2006; National Association of Insurance Commissioners, Multi-State Market Conduct Examination of the HealthMarkets, Inc. Insurance Companies (formerly known as UICI), The Mega Life and Health Insurance Company, Mid-West National Life Insurance Company of Tennessee, and Chesapeake Life Insurance Company (December 2007); General Accounting Office, Private Health Insurance: Employers and Individuals Are Vulnerable to Unauthorized or Bogus Entities Selling Coverage, GAO–04–312 (February 27, 2004); Larry Kirsch, The Illusion of Group Insurance: Discretionary Associations (Washington, D.C.: families USA, 2004).

² IRMI's Management and Liability Insurance Specialist (MLIS) curriculum is an excellent place to develop greater expertise on E&O coverages and marketing.