Avoiding E&O- When clients dissatisfaction moves to E&O claims

To paraphrase Abraham Lincoln, you can please some people all of the time, and all people some of the time, but you can't please all people all of the time. In a client-based profession, these words will always ring true. From insurance producers to attorneys, and all professions in between, we will inevitably have clients who are disappointed with some service we have provided–justifiably or not. As professionals, we must accept that our clients will not always be pleased, and may not recognize the extent of our efforts to achieve the result.

But where does client dissatisfaction cross the line and become an E&O claim? When should we report this dissatisfaction to our E&O carrier? These are hot issues that courts around the country consider with increasing frequency. As an insurance producer, you must keep them in mind not only when running your own agency, but also when counseling any professional insureds you have as clients.

Almost every professional liability insurance policy is a “claims made” policy, which typically provides coverage only for claims first made against the insured and reported to the carrier in writing during the policy period. Coverage also is provided for “potential claims,” which generally are defined as any act, error or omission that might reasonably give rise to a claim, provided the insured first becomes aware of the potential claim and gives written notice of it to the insurer during the policy period. Thus, the notice requirements of a “claims made” policy are different from those of an “occurrence-based” policy. Whereas late notice generally will preclude occurrence-based coverage only where the carrier has been prejudiced, a late report under a claims-based policy will void coverage even in the absence of prejudice.

It is relatively easy to recognize claims, which are typically defined as a written demand for damages received by the insured. If you are served with suit papers, you forward them to your E&O carrier to report the claim. But potential claims are not so easy to recognize, and present a virtual coverage mine field. Notably, claims-made policies typically do not provide coverage for potential claims based upon any act, error or omission that, at the effective date of the policy, the insured knew or could have reasonably foreseen would be the basis of a claim or lawsuit. This presents a large gray area, perhaps best demonstrated by the following hypothetical scenario.

Frank Frugal owns a home in a coastal area, and has insured it through Diligent Agency for several years. It is a modest second home he uses only during the summer months. Due to its location and the fact it is only seasonally occupied, property insurance is difficult to obtain and Diligent has placed the risk with the state's FAIR plan. Diligent has explained to Frugal it is a limited policy which covers named perils such as fire and vandalism, but notably excludes coverage for water damage. However, the policy is significantly cheaper than more comprehensive insurance available through surplus lines carriers, and Frugal finds this appealing.

During a particularly harsh winter, Frugal forgets to turn the water off and the pipes burst and leak throughout the entire house. He notifies Diligent, who reminds Frugal there is no coverage for water damage. Frugal becomes upset, claims he never knew the policy did not cover water damage, and questions why Diligent would sell him insurance that does not cover damage from burst pipes. Frugal writes a letter to Diligent expressing his disappointment, but takes no further immediate action. Diligent does not report anything to its E&O carrier at the time, Lucky Pro.

A few months later, Diligent changes E&O carriers and mentions nothing of the Frugal situation on the new application. Within weeks, Frugal files suit against Diligent, claiming Diligent should have placed better insurance for him. Diligent tenders the claim to its new E&O carrier, Hard Line Casualty, who retains counsel to defend the claim. Shortly thereafter, Hard Line becomes aware of the Frugal letter–which predated Hard Line's policy period–and files a declaratory judgment action seeking to disclaim coverage. Hard Line claims Diligent reasonably could have foreseen its actions would result in a potential claim, which predated its policy. Diligent then tenders the claim to Lucky Pro, which denies coverage because the claim was made and reported after Lucky Pro's policy expired, and because Diligent never reported the potential claim during the policy period.

Based upon these circumstances, Lucky Pro's position is virtually guaranteed to succeed. But what about the declaratory judgment action filed by Hard Line? Diligent would certainly argue that simple communications from a disgruntled client don't rise to the level of a potential claim that needs to be reported to its E&O carrier, and that it didn't believe Frugal intended to sue the agency. Is Diligent's argument sufficient to win E&O coverage from Hard Line?

The answer will depend in large part on whether the jurisdiction where Frugal's home is located employs a “subjective” or “objective” test in deciding whether Diligent could have realized a claim was forthcoming. In other words, does the court ascertain Diligent's awareness of a potential claim by determining whether Diligent subjectively believed a claim was forthcoming (“subjective”), or does the court look at the facts known to Diligent and determine what a hypothetical “objectively reasonable” insured would have appreciated (“objective”)? Under a subjective standard, Diligent likely would prevail. But under an objective standard–the majority rule–the outcome is far from certain for either Diligent or Hard Line. Some degree of subjectivity inevitably enters judges' minds even in objective jurisdictions, and case decisions are inconsistent.

In reality, and for practical purposes, it is important to realize that E&O insurance carriers increasingly are willing to try coverage disclaimers and declaratory judgment actions to void coverage under circumstances similar to those presented above. To protect yourself and your agency, you should–at a minimum–carefully read the language in your E&O policy regarding potential claims and reporting, and familiarize yourself with the nature of the jurisdictions (i.e., subjective versus objective) in which you routinely write policies. Furthermore, make it an internal policy for your agents and service representatives to document and report client dissatisfaction to management, and for management to carefully review all such instances in advance of your E&O policy replacement or renewal. It isn't just switching E&O carriers that implicates this issue; insurers will typically send out forms asking relevant questions prior to renewal of the existing policy with the same carrier.

If there is any question if a potential claim should be reported, the best practice–especially if you have received written letters advising of the dissatisfaction–is to report the matter to the carrier, perhaps with a written explanation of your version of events and why you do not believe any further immediate action needs to be taken. If you can proactively ensure coverage will later be available, you can avoid the headache of fighting your E&O carrier in addition to your insured.

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