Agent E&O: Protecting your clients (and yourself) during a recession

It is easy to understand that we are in a time of global economic and political change. However, it may be harder to assess how these turbulent times can impact you, your clients, your agency or your E&O coverage. Many in our society play the “victim” role all too well. Today, as people and businesses look for alternative sources of revenue and blame others for their problems, these “victims” may make a claim, meritless or otherwise, against any business. Without insurance protection, in either good economic times or bad, your clients would have to spend their own time and money responding to these claims, draining away the valuable resources they need to manage their businesses. And, more importantly, keep in mind that this advice applies to your agency, too, as a business operation. Many businesses experiencing declining revenues in the recession may decide that insurance and other risk management mechanisms are an unnecessary expense. These clients should be cautioned against this view, and offered guidance to manage their insurance expenses. “Given the current economic crisis, clients are in survival mode, seeking cost reductions at every level and recognize insurance as one of their largest expense line items,” said John Pierson, vice president of BB&T Insurance Services of Orange County, Irvine, Calif. “As a result, we are experiencing a tremendous amount of requests to shop the market for the low-cost leader, as well as presenting the client optional limits, deductibles and coverage to reduce costs.” Insurance agents and brokers must not only help clients manage their insurance expenses, but also warn them of the potential repercussions of reducing or eliminating coverages. The agent or broker also must assess the financial strength of the carriers being used and make the appropriate disclosures to the client regarding risk retention groups or surplus lines carriers. These warnings should be in writing to protect the insurance agent or broker from E&O claims. However, challenging economic times also bring opportunities in growing areas where insurance agents and brokers can focus their efforts. During 2008, employment levels declined in all industries except healthcare, education, certain technology-related niches and government. With the stimulus bills passed in Washington, industries that should benefit include healthcare, infrastructure construction, alternative energy, technology-related fields (e.g., electronic medical records) and various vendors serving the government. These growing industries will have various insurance needs–some required by contract or law–so insurance agents should specifically target these niches. The impact of unemployment An obvious–and negative–trend is the increase in the unemployment rate, which by March 2009 had climbed to 8.5 percent, the highest in 25 years. With employers implementing significant reductions in personnel, and record numbers of applicants for the existing job openings, possible allegations of race, age, sex and other type of discrimination claims may increase. Workplace discrimination complaints filed with the U.S. Equal Employment Opportunity Commission increased 15 percent for its fiscal year ending September 2008. With experts predicting the unemployment rate to rise to double digits, employment-related claims are likely to increase as well. Insurance agents should advise clients to purchase employment practices liability insurance if they have not already done so, to protect themselves against these types of claims. Insurance agents and brokers (and their insurers) are not yet experiencing an increase in E&O claims activity, but that is likely to change. The fear among many in the industry is that the worst is yet to come, as claims may not be made until after a party resolves his own claim or litigation (often unsuccessfully) with another party. Clients may have reduced their limits, eliminated insurance, or selected an inferior carrier to save money. Now, with a possible uninsured or underinsured claim, some clients may charge their insurance agent or broker with negligent advice or make similar allegations. This delay in a claim against the insurance professional may be problematic if the agency has reduced its own E&O policy limits to reduce expenses. “I believe this economic crisis will contribute to increased E&O claims against insurance agencies due to the cost-cutting measures many agencies are being forced to take,” said Scott Jones, principal, IMACO Insurance Services, Carlsbad, Calif. “For example, staffing reductions, elimination of services and consumer demand for the cheapest price may mean inferior markets and policy forms.” Business segments as varied as automobile manufacturing, banking and finance, and travel and leisure are under attack by government officials. No one can be sure what industry will be next to fall out of favor with the public at large, or be targeted by the government. As these businesses respond to increasing public scrutiny or government demands, many may blame their insurance agent or broker for the uninsured financial repercussions of their business decisions. This may lead to a rush of new E&O claims against insurance agents and brokers down the road. For this reason, insurance agents and brokers must maintain their own E&O insurance to protect them against this eventuality. E&O coverage: a snapshot The rates for insurance agent and broker E&O coverage do not seem to be increasing or decreasing. Despite the concern that E&O claims may increase in the near future, many insurance carriers seem to be taking a “wait and see” approach toward loss results and possible rate changes. Just as banks are using credit scores to determine who will receive loans, insurance companies also may tighten their underwriting standards. Insurance companies will target what they perceive to be the “best” accounts, such as those entities with comprehensive risk management programs. Agencies without effective risk management controls in place may pay higher rates or discover that many insurers are unwilling to offer terms at any price. An issue many insurance professionals and E&O insurers are facing is how to respond to the decreasing sizes of their applicants (new business) and current insureds (renewals), relative to premiums charged and covered exposures. Many agencies are experiencing significant year-over-year declines in terms of commission income, premium volume handled, and headcount–the three common criteria upon which most carriers base their E&O premiums. For this reason, agents may expect to pay reduced premiums for their E&O coverage–and indeed, many are. Most E&O coverage is written on claims-made coverage forms (“claims made” when referenced refers to “claims made and reported” policies rather than the less common “pure claims made”) that may include prior acts coverage for the agency. Insurance carriers are being asked to provide prior acts coverage for an insurance agency that may have been much larger in the past, but expect carriers to base their premiums on the current, much smaller, entity. Market pressure may influence individual insurers to take this approach, but charging an inadequate premium for the actual exposures, in the short term, may lead to long-term negative consequences for these carriers and, ultimately, the E&O insurance buyer. Eventually the math of losses paid out, compared with the premium collected, will result in higher loss ratios for the insurance companies. When E&O carriers raise rates to correct for these losses, or withdraw from the market altogether, insurance buyers will ultimately pay the price in higher premiums. If an insured has been with the same carrier for a number of years, and was paying premiums when the entity was larger, the carrier may weigh this during the renewal quote. The insurer may feel that it has collected premiums relative to the exposure in prior years, especially if the account has been profitable over time. However, when the same agency asks for a first-time quote from a new carrier, that insurer may be less inclined to offer a very aggressive price. They will feel that they are being asked to charge a much lower premium relative to the true exposure (i.e., many years of prior acts for an agency that was once much larger). E&O insurance buyers should have their agent or broker solicit multiple quotes, as insurance companies are in different stages of thought on this topic, and this may result in much different final quotes. As always, it is important for an insurance buyer to pay attention to the E&O policy’s terms and conditions. As agencies and their clients decline in size, purchase a competitor, sell their own business, merge with another entity, declare bankruptcy, or simply close their doors, some coverage features may come into play that would normally not warrant much attention. Let’s look at some of these features specific to insurance agencies. Addressing agency changes In rough economic times, one of the first expenses addressed by a business is personnel. With agencies that are eliminating positions due to declining income, agents should pay attention to the E&O coverage form as to whether past employees will continue to be included as insureds under the policy. If the agency must respond to an E&O claim involving the work of a former employee, the agency will most certainly want this former employee’s cooperation in the handling of the claim. Cooperation is greatly improved when that person is afforded insurance protection under the agency’s E&O coverage form. The agency should ensure that the definition of insured includes anyone who “is or was” an employee or other covered position so that individuals no longer employed are still covered for their past work that was performed for the insured entity. When economically challenged, some agencies may decide to buy, sell or merge with another entity. Each option presents E&O coverage issues. Most E&O policies specifically address these “change in control” situations, and the insurance agent or broker should be aware of the specifics before finalizing a transaction, to assure that there will be no gaps in coverage going forward. If an agency is sold or absorbed by merger, some E&O policies stipulate that coverage ceases immediately going forward, the policy premium becomes “fully earned,” and the policy is non-cancelable by either party. Coverage continues to apply for the pre-sale/pre-merger professional activities. Insurance policies are typically non-transferable (i.e., they are not an asset to be sold to new owners). What should you consider if you are buying an agency or consolidating with another entity? Two coverage issues come into play. First, the definition of “Who is an Insured” under the policy typically applies only to those entities named on the insurance declarations page. If a new entity is added, or the post-merger entity has a new name, do not assume that coverage applies to the new entity automatically. Some coverage forms include “predecessor firm” coverage that will protect the newly named entity if that entity controls the majority of the assets of the prior firm. It’s best to investigate, before the purchase or merger, how coverage applies and what steps will be required to add the new entity to the existing coverage and provide run-off coverage for the predecessor firm(s). Second, most E&O policies will provide coverage for newly purchased entities or for those created by merger only if the insurer is notified of the new entity within a certain timeframe, usually anywhere from 30 to 60 days. The insurer may make a premium charge for providing this additional coverage. This is especially important if the purchaser has assumed the liabilities of the purchased entity, including potential E&O claims. An agency owner may decide that it is best to simply cease ongoing operations. Because E&O coverage is typically provided on claims-made coverage forms, the entity must take steps to assure that insurance protection will continue to cover claims that may not be made until after the business has ceased operations. Generally speaking, under a claims-made policy, claims must be made before the policy’s expiration date. Once the policy expires, no further claims may be reported, although many policies do provide a short (30 or 60 day), free extended reporting period, which gives insureds time to report claims made just prior to the policy expiration. For coverage beyond that, an extended reporting period (ERP) must be purchased. An ERP provides an additional period within which E&O claims may be made for alleged negligent acts which occurred during the coverage period (i.e., after the retroactive date and before the expiration of the policy). In some circumstances, the insurer may be willing (or required, in some states) to reinstate the limits of insurance if an ERP is purchased. Common timeframes for ERPs range between 12 and 60 months, with 12 being the minimum length offered. Some policies stipulate that the cost of the ERP will be determined once it is requested. It is best to negotiate the cost and duration availability of the ERP before purchase of the policy, if possible, to avoid surprises later. Another feature of ERPs to consider is when this optional coverage may be requested and purchased. Two types of approaches are most common: unilateral and bilateral. With a unilateral ERP, the insured may have the right to purchase the ERP only if the insurance company elects to cancel or non-renew the policy. In other words, if the insured decides to cancel or non-renew, the ERP is unavailable. A bilateral ERP is available to the insured if either party elects to cancel or non-renew. The bilateral ERP is more favorable to the insured. A final feature about an ERP to consider is that many carriers offer it for no charge in the case of the death, total disability, or retirement of the insured. True in any economic climate, this feature can be especially helpful to an agency if the owners decide to retire. To activate this feature, a common requirement is that the agency be insured with the same insurance company for a minimum number of years, usually five. With economic and political conditions creating uncertainty, insurance agents and brokers have an opportunity to advise their clients what this means for them. To help minimize their exposures, insurance agents and brokers might consider targeting industries that may benefit both from this downturn and from stimulus efforts in Washington, rather than focusing on distressed industries. Examining one’s own E&O policy coverage is imperative as well. Planning ahead, staying focused on broader industry trends, and perhaps negotiating better terms and conditions of your E&O coverage can be key in navigating through this economic malaise.