All experienced insurance producers have come to understand that there are universal risks that human beings face every day, including the risks of death, disease, personal injury and property damage. Products that address these risks are discussed constantly within the industry, marketed effectively to the public and detailed extensively in countless texts.
Receiving less attention are those risks that apply to people in certain kinds of situations. The following course material addresses those less-discussed and sometimes less-understood risks, with an emphasis on the insurance needs of business professionals. Students will learn about or be reminded of the various insurance products that are geared specifically toward high-ranking corporate executives, doctors, lawyers, architects and others whose jobs expose them to greater liability risks than the average person. By studying this material, producers will also recall that they, too, are often viewed as professionals who can benefit from solid insurance coverage. The material speaks to those producers who have an interest in directors and officers insurance, errors and omissions insurance or malpractice insurance and contains general overviews and specifics of all three products.
But as valuable as that information might be, it represents only a portion of what professional liability producers must know in order to do their jobs as effectively as possible. While insurance professionals should obviously be able to understand and explain the products and services that are provided by their industry, they may struggle to succeed if they do not put these products and services into specific contexts and understand how a particular policy may or may not satisfy each professional�s unique needs. Producers will probably have a hard time selling a directors and officers liability policy, for example, if they do not first grasp what roles directors and officers play in an organization.
With that in mind, the material is as much about the risks encountered by various professionals as it is about insurance products. By applying such important background information to their business interactions with corporate directors and officers, lawyers, doctors and others, producers may become better equipped to match clients with the proper insurance product and may be more apt to recognize major deficiencies in coverage.
Directors and officers are business professionals who push their company toward achieving its financial and societal goals. Whether they serve or work for publicly held corporations, private companies or non-profit entities, their judgments and decisions can be monumental in size and can create positive and negative consequences that affect a company�s workforce, clients and major investors.
A �board of directors� sits atop a company�s chain of command and is expected to use its nearly supreme power to suit the collective interests of all shareholders. For directors of large and publicly traded companies, such responsibility might entail representing thousands of investors from around the globe. However, at many small and private companies, an organization�s directors are also its sole shareholders.
Board members who are employed by the company or have an otherwise personal stake in the company�s success or failure are known as �inside directors.� Those directors who do not work for the company and do not have a personal stake in the company�s success or failure are known as �outside directors� and are usually recruited by the board to add expertise, prestige and unbiased perspectives to the company�s dealings. Both inside and outside directors serve by the consent of a company�s shareholders, who can remove, reelect or install board members at regularly scheduled shareholder meetings.
A board of directors� tangible duties may include but are not necessarily limited to the following tasks:
� Hiring and firing major personnel
� Voting to endorse or discourage big business deals
� Formulating company policies pertaining to financial strategies
� Setting salary figures for executive positions
No matter the specifics of their decisions, directors must abide by various ethical standards that have long been a foundation for corporate law in the western world. When entrusted with shareholders� money, a director takes on fiduciary duties of care, good faith, loyalty and obedience.
A �duty of care� requires a person to become reasonably informed about a situation before making a decision and discourages even supposed experts from taking possibly hasty actions.
A �duty of good faith� forces directors to perform with unwavering honesty and encourages them to withhold no material information from shareholders.
A �duty of loyalty� ought to prevent directors from engaging in business activities that promote personal gain at the expense of shareholders and should entice directors to disclose any actual or perceived conflicts of interest that could arise in a given situation.
A �duty of obedience� requires a director to act in a manner that is compliant with the company�s charter and bylaws.
Many directors devote no more than a few hours each week to their board-related service and appoint �officers� (such as chief executive officers, chief financial officers and various managers) to handle important daily business tasks. A company�s officers are often expected to adhere to similar principles of care, good faith, loyalty and obedience.
Additional duties of directors and officers are detailed in the American Bar Association�s Model Business Corporation Act, which has been adopted in some form or another by many states. Some larger states like Illinois have also developed their own statutes to address these issues.
This assortment of fiduciary duties leaves even careful directors and officers vulnerable to numerous liability risks. According to a 2007 item in the University of Chicago Law Review, a publicly held company stands a 2 percent chance each year of being named as a defendant in a shareholder class action suit, and even if shareholders could be eliminated as sources of complaints, directors and officers would still have to worry about avoiding lawsuits that may be brought by customers, regulators, colleagues and employees.
A public company�s directors and officers are especially susceptible to harmful allegations when their company�s stock drops dramatically in value. Shareholders, as well as the Securities and Exchange Commission (SEC), seem more inclined than ever before to investigate suddenly failing companies in attempts to detect unlawful business practices, including failures to honor fiduciary duties and violations of federal securities laws. After scouring company reports and prospectuses, angry shareholders and government officials might allege that upper management filed inaccurate or misleading information with the SEC and thereby permitted corporate stock prices to become inflated far beyond their true value.
Of recent concern have been instances of �backdating.� As part of compensation packages, many companies give their directors and officers the option of purchasing company stock at a price determined by the organization. Backdating occurs when the price associated with stock options corresponds with a lower, earlier price that was in effect before the company ever granted such benefits to the recipient. Because the recipient is able to purchase company stock at a lower than current price, he or she will ultimately be able to sell the stock at a greater profit.
On its own terms, backdating is not always illegal. However, a company�s directors and officers expose themselves to tremendous liability when they receive or offer backdated stock options without proper disclosure. When documented inadequately, backdating can skew company earnings and allow other stockholders to successfully claim that management falsified or misrepresented materially important information to investors. If proven to be true, these accusations could make directors and officers liable for any monetary losses that a company�s backers may have incurred.
Directors and officers face other liability risks when their companies go through transitions and restructurings. Mergers and acquisitions that turn sour tend to make disgruntled parties wonder if directors acted responsibly and in shareholders� best interests. Shareholders might also allege that corporate decision makers did not satisfactorily seek out the best possible business deal for investors. It is also possible that affected employees will file suit in response to the undesirable changes that often occur at the workplace following a major business transaction.
For the purpose of future reference, it may be important to note here that many lawsuits filed against directors and officers (especially those actions involving securities) can be categorized as either �class actions� or �derivative actions.�
Even readers without any legal background are likely to already be somewhat familiar with the concept behind class actions. These actions basically involve several plaintiffs who have similar claims against the same defendant. At least within the context of corporate liability, class actions are usually filed by shareholders for their own relief and typically seek major monetary settlements or judgments.
Derivative actions arise when shareholders (who may or may not have lost money caused by a director or officer�s alleged misconduct) file a suit on a company�s behalf. Rather than asking for financial restitution, plaintiffs in derivative suits often seek settlements or judgments that will instigate improved corporate governance and managerial changes. Any money that passes from defendants to plaintiffs in a derivative action goes to the company that is linked indirectly to the case.
This does not mean, however, that a victorious shareholder gains nothing personal by pushing forward as the plaintiff in a derivative action. A well-publicized prosecution by the shareholder in a derivative action could perhaps save a company�s reputation during a critical period and put a company�s falling stock back on the rise.
Though many of the preceding examples of liability risks involve publicly traded stock and might seem like they are major issues only for the big companies that one reads about in national business publications, several additional liability issues can realistically affect directors and officers at companies of nearly all sizes and configurations.
Management at a private company is a solid target for suits when a business is forced to declare bankruptcy. This is especially true when a creditor provided financial assistance to a company just prior to the bankruptcy and was not allegedly aware of the company�s financial troubles.
Leaking confidential information about one�s company to a competitor or any other party for the purpose of financial gain could trigger legal action against directors and officers. It�s also possible that controversial hiring and firing decisions will provoke civil rights litigation.
Life was not always so risky for directors and officers, and, consequently, there was not always a need for them to insure their personal assets against legal claims.
Individual directors and officers were barely exposed to liability until the federal government passed major securities legislation in response to the Great Depression. Among other laws, a Depression-era Congress enacted the Securities Act of 1933 and the Securities Exchange Act of 1934. Together, these laws created the Securities and Exchange Commission (SEC) and began requiring that any offer or sale of securities using the means and instrumentalities of interstate commerce be registered and that documentation be filed with the new federal agency.
These laws also allowed buyers of federally registered securities to sue various parties if there were any false or misleading statements within securities registration documents. On the basis of the acts, anyone who buys a security that is linked to false or misleading SEC statements can sue the following persons:
� Signers of the disputed registration documents
� A company�s directors and officers
� Partners in a business
� Future directors and officers who consented to have their names listed on securities documents
� Accountants and appraisers who put the securities documents together
� Underwriters of the disputed securities
The individuals listed above may escape liability in some cases. A person can avoid liability if he or she resigned from the company before registration documents were filed with the SEC and informed the company and the SEC that he or she would not be responsible for the contents of future registration documents. People are also exempt from securities liability if they had no reason at any time to believe that there were any misstatements or misrepresentations in securities documents or if, upon discovering misstatements or misrepresentations, they promptly reported the problems and proclaimed their innocence to the public and the SEC. Trusted experts whose statements were used or interpreted improperly in relation to securities documents are additionally shielded from liability.
However, in order for any of these protections to apply, the accused needs to have taken the kinds of measures and precautions that would have been expected of a prudent and reasonable person. In assessing prudence and reasonableness in federal securities cases, the judiciary tends to compare plaintiffs� business practices to the way people would treat or protect their own property.
Though the Securities Act created a big enough stir in the 1930s for insurers to introduce coverage that was aimed specifically at directors and officers, it took several decades for business professionals to be concerned enough to consider purchasing directors and officers coverage (D & O).
In the years following the landmark securities laws, it was still far more likely that an angry shareholder would bring a company to court rather than pursue litigation against specific high-ranking individuals. In the few cases that did specifically name directors and officers as defendants, executives often benefited from broad judicial interpretations of the �business judgment rule.�
The business judgment rule is a commonly cited legal concept that attempts to fairly address the fact that a company�s decision makers are not infallible. The rule generally makes it legally acceptable for directors and officers to make mistakes or unpopular decisions, as long as the following criteria have been met:
� The people who made the decision lacked a conflict of interest.
� The people who made the decision were reasonably informed in regard to material facts and issues.
� The people who made the decision acted honestly.
� The people who made the decision were not acting beyond the boundaries of their authority.
The rule is also applied by the courts to the decisions that directors or officers fail to make.
Over time, the courts adopted a less rigid approach to the business judgment rule, and shareholders began having more success in court when challenging the decisions of directors and officers.
Escott v. BarChris Construction Co.
The case Escott v. BarChris Construction Co. has been cited by insurance experts as one example of a court tightening a director or officer�s responsibilities in regard to due diligence.
BarChris specialized in serving the bowling industry and capitalized on a boom in that sport following the 1952 invention of automatic pin-setting machines. According to court documents, the company had become the number-three builder of bowling lanes by 1960 and had constructed roughly 3 percent of all lanes nationwide.
As far as the public knew, BarChris did not operate bowling alleys; it built the interior lanes, installed the necessary equipment and then sold the alleys to a third party, who leased the alleys to the construction company�s customers. The company typically received a small down payment before starting work on an alley and received the rest of its compensation in the form of notes, payable at a later date, as work on an alley neared completion.
By 1960, BarChris assumed it could survive if one of its customers were to unexpectedly back out of a deal for one of the company�s alleys, but the business was unprepared when the bowling bubble burst in the early part of the decade. With too much supply and too little demand for lanes, the company was forced to repossess several alleys and chose to operate them on its own. Meanwhile, the company continued the construction of lanes, even though buyers had pulled out of deals midway through projects. In 1961, BarChris filed documents with the SEC in order to sell �debentures� (instruments similar to bonds), but the company�s financial struggles caused it to default on those debentures during the following year and eventually file for bankruptcy protection.
BarChris� failures provoked a lawsuit from more than 60 shareholders, who alleged the company had included errors and omitted material information from its SEC filings. Among those named in complaints were the signers of the SEC documents (including BarChris� directors), the company�s auditors and eight investment banking firms that had acted as underwriters.
Though courts did not agree with the suing shareholders on all counts, they did say the company had inappropriately included mere projections in its earnings statements, had wrongfully included a loan as part of company sales figures and had misstated its sales figures and operating income for 1960 by roughly $700,000 and $300,000 respectively. A judge also ruled that BarChris� sales, profits and liabilities for 1961 were inaccurate to the point of being material misrepresentations and that the company�s decision to operate bowling alleys in addition to constructing them made the stated nature of the business misleading to investors.
In response to some of the plaintiffs� accusations, BarChris officials claimed the auditing firm involved with the case was an expert on which the company had relied and said, based on their alleged due diligence, they had no reason to believe the SEC documents had included any false or misleading statements. This defense did not satisfy a U.S. district court, which suggested that handing off responsibilities to supposed experts did not shield directors and officers from liability and that signing one�s name on an SEC document creates liability for the signer, even if the person allegedly did not understand or even read the document.
Other rulings in the late 1960s amounted to additional victories for shareholders. But with the annual number of cases against directors and officers still in single digits during parts of the 1970s, there was no prolonged liability-related crisis that kept directors and officers in fear of being inadequately insured. Times had changed by the 1980s, when hundreds of lawsuits were being filed.
Directors and officers of top companies were reacting nervously to shareholder-friendly decisions, including the one handed down in Smith v. Van Gorkom, which made directors and officers liable for a bad business deal despite an absence of fraud or bad faith.
The Van Gorkom case centered on the controversial purchase of a company, TransUnion, by corporate takeover specialist James A. Pritzker. A TransUnion director had negotiated a proposed cash-out merger with Pritzker and called a board meeting in order to discuss the deal with colleagues. According to court documents, most of the board members did not know ahead of time that the meeting would involve their consideration of a merger agreement, and when they did learn of the Pritzker offer, their knowledge of it was confined to what was told to them in an oral presentation given by the negotiator, who allegedly understood the gist of the merger agreement but had not read it.
In essence, the merger agreement called for Pritzker to purchase interests in TransUnion at $55 per share, a $17 bump from the company�s reported market value of $38 per share. Despite having claimed in the past that TransUnion�s stock had been undervalued in the market due to tax issues, the board spent two hours discussing the proposal, compared the $55 dollar offer to the $38 market value and voted to accept the merger agreement without conducting any valuation studies. According to some defendants in the case, the board�s decision was based, in part, on legal advice it received, which cautioned that rejection of the merger agreement could leave directors susceptible to shareholder suits.
The original agreement between Pritzker and TransUnion permitted the latter company to receive competitive offers from other suitors for 90 days as long as TransUnion did not actively solicit those offers. But, when many TransUnion managers threatened to leave the company, Pritzker removed the ban on open solicitation in return for management�s promise to stay on board for an additional six months. In a second meeting, TransUnion�s board of directors approved this amendment to the merger agreement, allegedly without having examined it in written form. The board also called in an investment adviser to help with any competing offers that came in, though this person was not asked to give an opinion of the preexisting Pritzker offer.
Two other proposals, both of them larger than Pritzker�s, eventually came to TransUnion�s attention. These two prospective deals were accompanied by timing and funding problems and fell apart before directors could vote on them. During a third meeting, the board reviewed the chronology of events related to the Pritzker merger agreement and voted unanimously to accept the agreement again and recommend it to shareholders, who did indeed approve it on a later date.
In response to a class action suit filed by TransUnion shareholders, a court applied the business judgment rule to the case�s details and determined that the board of directors had made an informed decision and that shareholders had voted in favor of the merger after being made reasonably informed of the agreement by the board. On appeal, the Supreme Court of Delaware reversed the lower court�s ruling, claiming that the board was not reasonably informed of the merger agreement when it voted on the deal and that shareholders, as a result, had not been told all they needed to know about the Pritzker arrangement.
In stating its case, the court said that, contrary to claims made by the defense, the board had not adequately considered the merits and faults of the merger agreement during all three board meetings. From the court�s perspective, the board�s second meeting (the one pertaining to the solicitation amendment) had nothing to do with reconsidering the merger agreement; instead, it was all about setting up the possibility for additional agreements between TransUnion and Pritzker.
Furthermore, the court said the solicitation amendment would have only let the TransUnion board back out of the merger agreement if the company had managed to consummate another agreement with another buyer and get it approved by shareholders within the 90-day period for active solicitation. Because neither of the two competing offers had made it to a shareholder vote, the court found that the board�s third meeting (the one pertaining to its final vote on the Pritzker agreement) was not an opportunity for the directors to seriously reconsider the deal. Had the board voted against the agreement at that third meeting, it could have paved the way for a breach of contract dispute.
The court said shareholders could not have made an informed decision about the Pritzker suit since they did not know how much TransUnion shares were really worth at the time, and it concluded that the board�s actions amounted to a breach of fiduciary duties. According to the court, �Fulfillment of the fiduciary function requires more than the mere absence of bad faith and fraud. Representations of the financial interests of others impose on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances presented here.�
In short, the business judgment rule, cited by the earlier court, could not shield the directors from liability. The case resulted in a $23.5 million judgment against the directors.
Some insurance veterans, as well as observers of corporate America, have since credited the Van Gorkom case with ushering in a D & O insurance crisis that affected many companies during the 1980s. Good demand for protection enticed insurers to continue selling liability policies to directors and officers, but underwriting became tighter, coverage became more restrictive and premiums went up for some businesses.
Seemingly for the first time, the availability of adequate insurance coverage became a sticking point for those business professionals who were asked to serve on corporate boards. For example, according to the Wall Street Journal, the manufacturing company Armada lost eight of its 10 board members, including its chairman and CEO, when the company opted not to absorb the $720,000 annual premium for a $10 million D & O liability policy. At the same time, some companies attempted to keep their D & O premiums down by putting restrictions on the kinds of suits shareholders could bring against directors.
As the size and frequency of securities suits grew, the federal government tried to find ways to weather the storm. One such effort arrived in the form of the Private Securities Litigation Reform Act of 1995. Under the act, a securities suit may be dismissed if the plaintiff fails to make specific charges against a defendant. Plaintiffs cannot base their entire case on a mere decline in a security�s value. They must allege that the defendant made misleading statements or omissions, point to the exact misleading statements or omissions and explain how a defendant�s actions constituted a misleading statement or omission. There also must be an allegation that misrepresentations led to economic losses for the plaintiff.
Despite the change in federal law mentioned above, D & O insurance continued to be a must-have benefit for many people associated with Fortune 500 companies. Even inside the most ethically upright boardrooms, the possibility of a single eight-figure judgment against directors and officers was still frighteningly strong, and liability concerns became even more urgent when massive financial failures at companies such as Enron and WorldCom became front-page news.
With corporate scandals resulting in significant losses for Americans of all classes and backgrounds, it was inevitable that post-Enron directors and officers would be subjected to greater regulatory scrutiny and ordered to perform their duties with a higher degree of care.
The Enron and WorldCom fallouts were at least partially responsible for the bipartisan passage of the Public Company Accounting Reform and Investor Protection Act on July 30, 2002. Among other things, this act � more commonly known as �SOX� or �Sarbanes-Oxley� in honor of its two main congressional sponsors � did the following:
� Set up auditing requirements for U.S. companies and some foreign companies
� Forced public companies to disclose changes in their financial health
� Denied executives the right to sell their company stock during blackout periods
� Gave whistleblower protection to people at public companies who report poor accounting practices to proper authorities
The act also extended the timeframe during which a plaintiff may sue for securities-related damages. Prior to SOX, stockholders could sue directors and officers in a securities case no later than one year after learning about possible impropriety or three years after the impropriety allegedly occurred. SOX changed the limit on these actions, and investors can now file securities suits no later than two years after learning about possible impropriety or five years after the impropriety allegedly occurred, whichever happens sooner.
In printed form, Sarbanes-Oxley fills more than 60 standard pages and was broken down by its authors into more than 40 sections. Rather than go into detail about the entire law, we will focus on two sections of the act that should stand out for many directors, officers and insurance professionals. The two parts of the act that receive special mentions here are sections 302 and 402.
Section 302 of Sarbanes-Oxley deals mainly with the periodic financial reports that public companies must file with the SEC in accordance with the Securities Exchange Act of 1934. These reports cannot contain untrue or misleading statements nor have material information omitted from them. When executives sign these reports, they certify that they have read and reviewed the reports� contents.
Section 302 of SOX makes the people who sign SEC reports responsible for a public company�s �internal controls,� which are designed to prevent inaccurate accounting. Signers are required to review a company�s internal controls no earlier than 90 days before they put their name to an SEC report and must make their findings a part of that SEC report. Signers must tell the company�s auditors and board of directors about any existing or potential problems that may be attributable to faulty internal controls and about any instances of fraud that involve someone who is associated with the company�s internal controls. Corrective measures taken by signers in regard to internal controls must be noted in SEC reports. In addition, public companies are not exempt from the requirements in section 302 if they restructure themselves and head overseas.
Under Section 402 of Sarbanes-Oxley, a public company cannot directly or indirectly give credit to its directors and officers or arrange for a director or officer to receive credit or a loan. Among other exceptions, this prohibition does not apply to credit or loans that pre-date Sarbanes-Oxley, as long as the credit or loans are not renewed and there are no modifications made to the lending or crediting agreements.
Section 402 is particularly important to insurance professionals because of the popularity of �split-dollar life insurance policies.� Split-dollar life insurance policies are bought by companies and insure the lives of their employees. When the insured person dies, the company receives either the policy�s cash surrender value or the amount of money it paid in premiums for the insurance. Any excess death benefits go to the insured�s chosen beneficiary.
Split-dollar life insurance may be structured as either an �endorsement policy� or an �assignment policy.� In an endorsement split-dollar arrangement, the premium-paying company owns the policy on the employee�s life. In an assignment split-dollar arrangement, the employee owns the policy on his or her own life but assigns part of the policy to the premium-paying company, as if the insured were borrowing money from the company and using part of the death benefit to repay the loan.
In response to SOX, insurers contended that split-dollar arrangements constituted rewards to employees rather than loans. But with the IRS already treating some of these arrangements as loans for tax purposes, many companies did not know how to proceed with sales of these policies. Section 402 contained no definitions of �loan� or �credit� as they pertained to securities law, and the SEC gave no indication to carriers that it would provide any guidance on the issue in the near future.
Some legal and insurance experts predicted that the uncertainty over split-dollar life insurance and the criminal penalties attached to Section 402 (individual penalties of up to $5 million and 20 years in prison, and company penalties of up to $25 million for a violation) would eradicate this popular employee benefit from publicly held companies. Unfavorable rulings by the Internal Revenue Service have made the use of split-dollar life insurance even less desirable.
For obvious reasons, the passage of Sarbanes-Oxley and the general public�s attention to the scandals at companies like Enron caused directors and officers to focus even more on their exposure to liability. With the new law in place and corporate restatements on the rise, publicly held businesses worried that they would soon be confronted with suits, regardless of any actual wrongdoing on their parts. At this point, it was clear that having a corporate secretary take accurate, extensive notes at board meetings or not being present when controversial decisions were made would not always save a director or officer from serious legal trouble.
Faced not only with the potential for courtroom defeats but also with the prospect of having to pay steep settlements and enormous defense fees, directors and officers once again turned to their companies and began asking questions about their D & O liability coverage.
In general, people�s liability concerns did not lead them to resign from their high-ranking positions. Companies, nonetheless, began to recognize that having a solid D & O liability insurance package in place could be good for their bottom lines and that decent coverage was one of several valuable recruiting tools within a competitive market for prospective board members. In a survey conducted by the professional services firm Towers Perrin, roughly half of respondents at public and private companies said prospective directors and officers had asked about D & O liability insurance in 2005. Approximately 20 percent of respondents at public companies said prospects� inquiries had led to a change in the kind of coverage offered by their company.
Of course, insurers that specialized in D & O policies had been keeping close tabs on the developments at Enron and in Washington. They understood, at least equally as well as their clients did, that the Sarbanes-Oxley requirements and the public�s increasing vigilance toward corporate fraud had helped liability for directors and officers balloon to previously unseen proportions. They knew that with greater risks to insureds came greater risks for insurance companies, which, at the end of the day, would be the entities responsible for paying those expectedly higher defense fees and plaintiff awards. Some also reasoned that potential prison terms for Sarbanes-Oxley violations would entice even innocent companies to settle with their accusers at the insurer�s expense rather than do battle in court and risk being put behind bars.
These factors made underwriting D & O liability risks more challenging for insurance companies, and many providers decided to use greater caution by increasing premiums and reevaluating the risks posed by certain clients. An energy trade publication claimed in 2003 that oil and gas companies, which had collectively been subjected to only one securities-related class action suit prior to the Enron debacle, were having serious problems securing adequate liability coverage for themselves and their employees.
Today, companies� desire for coverage and insurers� occasional hesitancy in offering it send the same basic yet important message: The liability risks for directors and officers in the 21st century are real and should not be taken lightly.
It would be silly for us to digest all this information and assume that a company�s directors and officers are the only people who expose themselves to professional liability at work, or more importantly, that directors and officers are the only people who can protect themselves through specially tailored liability insurance.
�Professional liability insurance� � which, for our purposes, is a somewhat broad product category that includes errors and omissions coverage and malpractice insurance � is commonly bought by medical professionals, engineers and lawyers. It may also be useful for accountants, real estate professionals and, of course, insurance producers.
In fact, just about anyone who performs a service and passes himself or herself off as an expert might be more exposed to liability than the common worker. By drawing attention to their credentials, these professionals allow clients to expect reasonably high levels of care and quality in the services provided to them. When these services do not live up to those standards, there is not only the possibility that a lawsuit will materialize but also a chance that the plaintiff will receive a large monetary judgment from a judge or jury.
Liability can arise from the allegedly low quality of a provided service, as well as from the professional�s failure to provide the service in a timely manner. Contrary to a surprisingly popular belief, a client who has an issue with the quality or speed of professional services can successfully sue for an amount above what he or she paid for the services.
From the general public�s perspective, professional liability insurance is probably associated mostly with the malpractice coverage that protects the personal assets of medical workers.
Risk management is important for doctors, nurses and even the world�s remaining midwives because, through their actions and advice, these assorted professionals may establish relationships with patients that create a duty of care. In some cases, the professional�s duty to care properly for patients may apply not only to his or her personal actions and advice but also to any actions or advice rendered by medical staff members who are under the professional�s supervision.
Furthermore, the duty of care is not necessarily confined to a hospital or a doctor�s office. Depending on the circumstances, a medical professional may unknowingly establish a duty of care and create liability issues by casually diagnosing people�s problems in informal settings, such as at a party or on the street.
Few readers will be shocked to read that the medical malpractice issue is a tremendously controversial one that divides patients and politicians and sometimes pits doctors and insurers against legal professionals. At issue is the manner in which many malpractice settlements and judicial rewards incorporate much more than tangible economic damages. Defendants and their insurance companies are often being asked or ordered to pay for seemingly incalculable damages, including patients� pain and suffering as well as �punitive damages,� which are designed to punish or make an example of alleged wrongdoers.
States and the federal government have been slow to put limits on these non-economic damages, and some people believe that damages for pain, suffering and punitive purposes are being inflated unfairly by allegedly self-interested attorneys who work on a fee contingent on the size of the settlement. Others, however, point to instances in which doctors have acted irresponsibly in monitoring a mother�s pregnancy or operated on the wrong body part and say limits on punitive damages do a disservice to irrevocably harmed patients and families.
No matter if major malpractice victories for plaintiffs are the result of a few overly aggressive attorneys, a handful of disturbingly incompetent physicians or some combination of these two causes, the bottom line here is that the medical community has lost enough court battles in the past few decades for there to be a long-standing coverage crisis in the United States. Over the years, many insurance companies have either raised premiums considerably for medical malpractice clients or stopped selling policies that help medical workers manage their liability risks.
While many doctors have gulped at the sight of their rising insurance costs and have reluctantly continued paying premiums, others have responded differently with changes in the way they structure their personal finances and the way they interact with patients. Rather than pay high premiums for malpractice insurance, a physician might opt to �go bare� and purchase no coverage at all. As precautionary measures, the bare practitioner might transfer his or her personal assets to a spouse in order to keep them off-limits in a settlement or unfavorable court decision, or the person might force prospective patients to sign long-winded forms that limit their right to sue in the event of medical negligence.
But, as has been pointed out by contributors to such legal and medical publications as Medical Economics, these defensive strategies have holes in them. A nasty divorce could work against a doctor who transferred all wealth to a spouse, and a form that overly prohibits patients from suing their doctors may be deemed unenforceable by some courts.
Insurance and medical experts sometimes argue that the high cost of malpractice coverage has direct and indirect effects on patients. For example, a doctor might compensate for higher insurance premiums by charging more for services. A physician might also feel inclined to practice �defensive medicine,� which sees the patient being subjected to arguably unnecessary treatments in order to protect the doctor from potential suits. Though defensive medicine can help doctors pinpoint a proper diagnosis by eliminating some long-shot possibilities, its critics claim it is responsible for a significant portion of health care costs in this country and is therefore partially to blame for rising health insurance premiums.
Coverage shortages also have the potential to create physician shortages. Skilled doctors in high-risk medical fields have been known to stop offering certain services in attempts to save on insurance and reduce liability risks. Others have moved their practices to states where malpractice insurance is cheaper, have become specialists in less hazardous areas of medicine or have decided to save money and stress by completely abandoning their medical careers.
Malpractice claims against lawyers may result from any instance in which a lawyer makes an error that has a negative impact on a client�s case or causes unreasonable financial damage to the client.
Since wronged individuals are more likely to receive compensation from a negligent lawyer when that lawyer is covered by malpractice insurance, legislators from across the country claim an attorney�s insurance status is a material fact that should be disclosed to prospective clients. The American Bar Association has supported insurance disclosure requirements for lawyers, and, by 2007, roughly 20 states had put such disclosure requirements in place, according to the San Francisco Chronicle. In general, the states that mandated disclosure required lawyers to either reveal their insurance status on annual reports (which were subsequently made available by the states over the internet) or disclose their coverage status on documents sent to clients.
Like liability coverage for doctors, malpractice policies for legal professionals are expensive. Annual premiums can amount to thousands of dollars, and many small law firms have determined that they would rather take their chances and go bare than put down piles of money for sufficient insurance. When reporting on a potential malpractice insurance disclosure law for California legal professionals, the trade publication Lawyers USA cited a 2001 study, which found that nearly 20 percent of private-practicing lawyers in the state lacked coverage. In 2007, Oregon was offering legal malpractice insurance at set prices and was the only state in the country that required lawyers to be covered by a malpractice policy.
Professional liability insurance is also a frequently important product for engineers, architects and other skilled people who are responsible for building or designing various structures. These professionals can find themselves in legal trouble if construction takes longer or ends up costing more than was originally agreed upon by the builder and the client.
A job completed on time and under budget can be problematic, too, if the finished structure presents safety hazards to clients or the public. Someone who is injured at a property might sue a designer�s client, who might turn around and sue the designer for negligence. Or a physically injured party might take direct legal aim at a design or construction company and its workers.
It should be noted, however, that many states have enacted �right to repair� laws, which allow builders to fix structural problems within a specific time period and avoid a potential lawsuit.
With so much of an insurance producer�s time devoted to sales and the management of other people�s risks, it is possible for producers to become distracted by daily business tasks and unintentionally ignore the liability risks in their own lives.
This is unfortunate for a number of reasons. On a societal level, a producer who does not adequately understand the liability risks within his or her profession could engage in unintentionally negligent behavior that does significant damage to innocent consumers. On a personal level, agents and brokers who do not know how to manage their own professional liability are putting their careers and personal assets at great risk.
Liability insurance for insurance producers, which falls under the category of �errors and omissions� coverage, was relatively uncommon as recently as 20 years ago. But today�s disputes between carriers and policyholders are often traced by one party or the other to a producer�s alleged misconduct, making a quality errors and omissions policy more of a valuable safeguard than in decades past.
A producer can be sued if he or she was poorly trained in a policy�s features and exclusions and misrepresented those features and exclusions to insureds. Misrepresentations made by the insurance producer may lead to successful legal outcomes for policyholders if the misrepresentation occurred prior to a claim and influenced an insured�s choice to purchase a policy. On the other hand, a misrepresentation is a comparatively minor problem, at least from a legal standpoint, if it is made after the policyholder has filed a claim, since the misrepresentation had no bearing on the person�s decision to buy the policy in the first place.
Liability and the Producer-Consumer Relationship
In some cases, knowing a policy from cover to cover and being able to answer a prospect�s questions will still not be enough to protect an insurance professional when a client suffers an uninsured loss. Some courts have ruled that producers have special relationships with their clients, which make insurance producers responsible not only for explaining policy issues and obtaining requested coverage but also for assessing a client�s risk potential and alerting an insured to coverage gaps. A court might rule that a producer had a heightened duty to advise an insured under the following circumstances:
� There was a long-term relationship between the producer and the insured.
� The producer charged a fee for services in addition to a commission.
� The producer was the insured�s lone source for insurance information.
This does not mean, however, that producers with a duty to advise are free to make statements and recommend courses of action that are beyond their areas of expertise. Insurance agents can be sued successfully, for example, if the advice they dispense to clients relates to financial planning as opposed to risk management.
On the opposite end of the spectrum is the belief that an insurance producer is not an adviser and should therefore follow through with securing the coverage requested by a prospect, even if the producer disagrees personally with that course of action. Proponents of this belief may even go so far as to argue that there is an implied contract between the producer and the prospect and that a producer�s failure to obtain requested coverage for a prospect represents a breach of that contract.
This general idea was addressed in the case Avery v. Diedrich. In the Avery case, a couple inherited property that was insured by a $150,000 homeowners policy and asked an insurance agent to increase coverage on the home to $250,000. The agent, having visited the home, doubted the property was worth that much and said a $100,000 increase on a $150,000 policy might arouse suspicion at an insurance company. The owners agreed to have the home reassessed and to get back in contact once the assessment was completed.
The couple went ahead with the assessment, but no one alerted the agent to this fact until after a fire had destroyed the home at a replacement cost of $250,000. The couple sued the agent and got a favorable ruling from a circuit court, which said the agent should have followed through on his insureds� requests for enhanced coverage and was therefore liable for the loss.
On appeal, the Court of Appeals of Wisconsin, District Two acknowledged that state law made agents liable for losses when they agree to obtain coverage for consumers and do not follow through. But the court said an agent is not liable when a consumer requests coverage and the agent does not agree to obtain it.
Liability and Insurer Solvency
Sometimes a producer�s liability is tied not to misrepresented or unsuitable policy terms and conditions but to the financial health of the insurance company that issued the policy.
Unfortunately, unforeseen catastrophes, poorly analyzed business plans or some combination of the two can push an insurer into a state of insolvency. When insolvencies occur, policyholders� valid claims may not be paid. A claimant might have to wait several years before he or she is reimbursed for an insured loss and even then might still only receive a mere fraction of a claim.
Policyholders who find themselves in this distressing situation might point their finger at an insurance producer and wonder if the person should be punished for putting them in such a mess.
A court ruled in one case that an agent is not liable when he or she places coverage in good faith with a seemingly healthy insurer and insolvency occurs at a later date. However, producers might be liable for clients� losses when they knowingly place coverage with a financially shaky insurer that ultimately becomes insolvent.
Liability and Procedural Duties
So far, our exploration of an insurance producer�s liability risks has focused mainly on big-picture concepts such as suitability, service and knowledge. These concepts should be unquestionably important to the professional who wants to serve the public admirably and keep legal disputes at a minimum, but the reader should not forget that there are also some procedural aspects of an agent�s job that are just as relevant to our liability discussion.
In regard to policy application forms, insurance producers can get into legal trouble if they allow a prospect to merely sign a blank form and then fill in the requested information on their own. If producers receive a completed application and believe it contains an error, they should probably not make any corrections to the document without first checking in with the prospect and the insurance company.
When coverage has been issued, a legally prudent producer should report claims to carriers in a timely manner. Coverage that is to be replaced should not be cancelled until coverage under the replacement policy has taken effect.
Having established what some of the major liability risks are for people in various professions, we ought to state something that every successful insurance producer probably already understands: Merely recognizing that a risk exists does not, on its own, make people any less susceptible to unpleasant perils. People who are worried that a certain risk may have a negative impact on their lives need to take the next proactive step and find ways to manage that risk.
As in most of the risks we face in our lifetime, we can reduce our exposure to professional liability by altering our behavior and adhering strictly to various rules. But nothing can guarantee we will avoid all legal problems. A single, uncharacteristically lazy error in judgment can saddle an otherwise upright professional with a guilty verdict from a court, and careful business practices are not always going to help good people pay to defend themselves against others who are intent on filing frivolous lawsuits.
Because mistakes happen and because a client�s motives and sense of reasonableness can be so unpredictable, professional liability insurance exists as an extra layer of protection for risk-averse businesspersons in many professions and industries.
Most people who could benefit from a professional liability policy do not need to hear an insurance producer go on and on about how insurance, as a general product, can reduce economic hardship during a crisis. They see the value in insurance and have demonstrated their understanding of risk management by obtaining homeowners insurance, health insurance, life insurance and auto insurance for themselves and their loved ones.
Still, these veteran insurance buyers might need a producer to point out how a professional liability policy fits into and enhances their coverage portfolio. In truth, some prospective clients might be correct when they claim to have no need for professional liability insurance. But their reasoning is probably faulty if it is based on the premise that they are protected from professional liability through their homeowners policy or a general liability policy.
The liability side of a homeowners policy provides almost no protection for a homeowner�s business even if the business is operated from the home. While certainly more business-friendly than homeowners insurance, coverage under general liability policies has gotten narrower over the past few decades and is unlikely to protect policyholders when they are negligent in their renderings of professional services.
If potential buyers recognize the possible need for a professional liability insurance policy, they might next want to know how this product is made available to insureds and what the market for the product is like.
Professional liability insurance is often secured for individuals by their company. Insurance producers might be covered for errors and omissions through their agency, and lawyers might be covered for malpractice through their firm.
When a company purchases liability insurance for its professionals, it may choose to also include coverage for contracted workers and former personnel in addition to current full-time employees. If a professional is not covered by his or her company or does not believe that the company�s professional liability coverage is sufficient, that person can shop for an individual policy.
Desired liability coverage may be bought on the mainstream insurance market from an �admitted insurance company,� which has had its policies and premiums approved by the insurance department in the buyer�s state. The assorted coverage crises among the professional ranks have also seen a lot of companies and individuals buying professional liability insurance alternatively from a �non-admitted carrier.� A non-admitted carrier is an insurance company that has not had its rates or policies approved by the insurance department in the buyer�s state.
Non-admitted carriers do not escape regulation entirely, but their policyholders will not be reimbursed by a state guaranty fund in the event of insolvency, and some other consumer-friendly features may be missing from their products. A producer typically cannot pair a prospect with a non-admitted insurance company unless the prospect has been denied coverage by admitted carriers.
For simplicity�s sake, this course material groups malpractice insurance, errors and omissions insurance and directors and officers (D & O) insurance together whenever possible. Yet the reader should keep in mind that an insurance company will probably not underwrite and offer all kinds of professional liability insurance in the same way. A given carrier might feel comfortable giving reasonably priced liability insurance to lawyers but demand that doctors pay comparatively high premiums for malpractice coverage. An insurer that is a leader in errors and omissions coverage for insurance agents might not even have an errors and omissions product on the market that covers architects or engineers.
Such non-uniformity in the liability market probably does not come as much of a surprise to readers and is in no way meant to imply that insurance companies are engaging in unethical discrimination toward certain members of the professional world. After all, each professional group presents a unique brand of liability risks to the insurance community. Directors and officers, for example, expose their liability insurers to securities-related liability while not exposing them to many risks pertaining to health issues. The reverse is true for doctors with malpractice coverage. A doctor�s liability insurer may have to brace itself for a wrongful death claim but will probably not need to worry so much about a physician getting into trouble with the SEC.
The differing risks that apply to directors, officers, doctors, lawyers and other groups are reflected not only in the cost and availability of job-specific liability policies but also within the content of the insurance contracts. The remainder of this section addresses the contractual relationship that exists between a professional liability insurance provider and its policyholders. Many of the general topics covered in the following pages are relevant in some way to all of the professions we explored in earlier sections, but special attention has been paid to specific professions where possible and appropriate. Students who plan on serving professional clients well are advised to familiarize themselves with each client�s unique set of liability risks in order to find and negotiate policy language and features that best meet the buyer�s needs.
As we focus less on liability risks and more on liability coverage, it will be important for us to understand some basic distinctions between D & O insurance and all the other insurance policies that are featured in this chapter. To an extent, D & O insurance is like malpractice insurance for high-ranking decision makers at public, private or non-profit companies. On a fundamental level, the insurance is meant to protect directors and officers when they perform their duties in good faith but are still personally sued by shareholders or other parties.
Over time, D & O insurance has evolved into a product that also repays companies when they indemnify their directors and officers directly for any loss of personal assets. It even sometimes covers the company as a whole against losses incurred in securities disputes.
Coverage for individuals is limited to the liability that stems specifically from their roles as directors and officers and usually does not extend to any rendering of professional services. If doctors serve on a company�s board of directors, they may be covered for the unpopular business decisions they make at board meetings. However, they will not have coverage under their D & O policy for any mistakes they make in treating or advising patients.
For the purpose of another example, consider a person who has multiple roles in a company, serving as a board member and as general counsel. A D & O policy might cover the person for legal advice given to the board but leave the individual uncovered for the services and advice that are provided beyond the boardroom.
Despite being a single contract, a D & O insurance policy can cover several people. In addition to covering current directors and officers, a policy might provide protection for past directors and officers, as long as a claim relates to their previous service as a director or officer. It might also protect future directors and officers as they assume their positions. Directors and officers insurance can even be set up to cover lower-ranking employees when they are named in suits along with directors and officers.
A company�s D & O policy might cover directors and officers when they serve concurrently as directors or officers with other organizations. When this coverage exists, it is often limited to instances in which the director or officer was specifically asked by the company to serve on the board of directors of a non-profit organization. Coverage that extends to a for-profit director or officer�s service at a non-profit organization is limited to the individual and does not protect any other board members at the non-profit entity.
The typical D & O policy insures inside directors and outside directors, making no distinction between the two. But recent years have seen the development of a small market for D & O coverage that has been geared specifically toward outside directors, who may want to distance themselves from insiders in serious legal disputes.
D & O insurance can reimburse directors, officers and companies for monetary losses that stem from a suit, including defense costs, settlement costs and damages awarded to plaintiffs by a court. Most but not all D & O policies limit coverage to claims in which a person or other entity is seeking monetary damages from an insured party. This means that the D & O insurer can refuse to reimburse a person or company for legal costs when the central legal issue is an alleged criminal act that does not involve economic damages to plaintiffs and when the company is being investigated by the federal government for possible misconduct. Other D & O policies cover these claims under limited circumstances.
Unlike insurance for workers compensation and personal automobiles, liability insurance for directors and officers has no standard form. However, the typical D & O policy has a three-sided �insuring provision,� also known as an �insuring agreement.� An insuring agreement or insuring provision explains the circumstances under which an insurer will pay a claim. Coverage under the insuring provision of a D & O policy can be broken down into Side A coverage, Side B coverage and Side C coverage.
�Side A� is the classic coverage that has existed ever since insurers started selling D & O policies in the 1930s. It protects directors and officers� personal assets by paying for defense costs, settlements and court-awarded damages when a company cannot or will not compensate or �indemnify� its directors and officers for those losses.
Side A is especially important when derivative suits are possible, because states may prohibit companies from indemnifying their directors and officers for derivative losses.
Unless the specific details of a claim allow the insurer to invoke a policy exclusion, claims made against Side A will be honored if they are reported in a timely manner and do not exceed a policy�s monetary limits. In some cases, there will be no deductible for a Side A claim.
�Side B� of a D & O insurance policy allows a company to be reimbursed by the insurance company when it indemnifies its directors and officers in liability disputes. When D & O coverage was introduced to the world, Side B was nonexistent because companies were not yet allowed to indemnify their directors and officers for liability losses. This prohibition faded away for the most part, and Side B now accounts for the majority of D & O claims at many companies.
A company�s stance on indemnification for its directors and officers will depend on what state law forbids, what state law requires, what state law permits and whether or not a company wants to exercise its options under state law. If a state has adopted the most recent edition of the Model Business Corporation Act, which was proposed by the American Bar Association, indemnification in that state is not permissible when a director profited illegally from his or her actions. Under the model act, a director can be indemnified under the following circumstances:
� He or she acted in good faith.
� He or she performed duties in a manner that was in the company�s best interests.
� In the event of a criminal proceeding, he or she did not reasonably believe that a crime was being committed.
The act allows directors and officers to receive advance money from their company for defense purposes if they attest to their good faith in writing and agree to repay defense costs to the company if a final judgment by a court ever makes them ineligible for indemnification. The act does not call for directors to prove their ability to repay defense costs before they are allowed to receive them. The act states that directors must be indemnified for their losses when they defend themselves successfully in court.
As helpful as D & O policies might have been during their first 60 years or so in existence, sides A and B brought along some initially unforeseen complications. Then, as now, plaintiffs assumed that a company�s pockets were often deeper than those of its directors and officers, so many securities cases and other suits named companies as defendants along with the names of allegedly negligent individual executives.
Shared liability among directors and officers and their companies created confusion as to how settlement costs, legal fees and damages would be handled by a D & O insurer. Would a policy cover all claims under this circumstance, or would it only cover the directors and officers� losses and require the company to pay for its own defense costs and damages? Unsurprisingly, insurance companies tended to prefer the latter, more limited interpretation of the typical D & O insuring agreement, while businesses favored a broader reading of an insurer�s coverage obligations.
Confusion over shared liability was supposed to have decreased after most D & O insurers raised their premiums and added �Side C� or �entity coverage� to their policies. Side C is liability insurance that covers a company when it is accused, along with its directors and officers, of wrongdoing. On occasion, it may also cover a company even when an individual director or officer has not been named in a legal complaint.
For publicly held companies, coverage under Side C may be limited to claims stemming from state or federal securities cases or perhaps to employment-related disputes. Private companies, which do not sell securities to the public, might have Side C coverage that is limited to employment practices liability. Students will read more about employment practices liability later.
Side C may have created just as many allocation problems as it solved. Critics of entity coverage have argued that, when coupled with the company reimbursement provisions under Side B, Side C ignores the original purpose of D & O insurance and makes the product more of a company-geared item than something that protects individuals from losing their personal assets. Many directors and officers fear that claims under sides B and C could swallow up all available benefits under a D & O policy and leave individual directors and officers with no remaining protection against Side A claims.
The benefits available to companies under sides B and C of a D & O policy also put directors and officers� Side A coverage in jeopardy when a company is facing bankruptcy. Because companies receive money from insurers through sides B and C of a policy, bankruptcy courts have sometimes treated D & O insurance entirely as a company asset and have blocked the flow of insurance benefits that would have otherwise gone to individual insureds under Side A.
Many D & O insurance producers believe the problems made possible by sides B and C can be managed adequately through the purchase of �Side A-only� coverage. As its name suggests, Side A-only insurance is supplemental D & O insurance that only covers Side A claims.
Side A-only might just increase the amount of money made available for Side A claims and entail all the exclusions that apply to Side A in the primary policy. Or, with �difference-in coverage� Side A-only, the supplemental coverage�s exclusions may be narrower than the exclusions in the primary policy. For example, a claim that has been denied under the terms and conditions of a primary D & O policy because it pertains to pollution may be covered under Side A-only.
Side A-only has existed since the 1980s but wasn�t sold very often at first. According to an article in the Employee Relations Law Journal, some people were not in favor of the product, believing that its widespread acceptance would ultimately encourage companies to avoid indemnifying their directors and officers when legal problems arose.
The added insurance became a hot topic in the early 21st century as class actions against Enron and other companies reached their conclusion. The fallout at Enron resulted in directors and officers at that company having to give up millions of their own dollars to plaintiffs in class actions. A handful of D & O producers cautioned that clients without Side A-only coverage left themselves susceptible to a similar fate.
An opposing group, while not dismissing all uses for Side-A only, looked at the details in the Enron example and suggested that the facts of the situation did not merit such a strong sales pitch. Those who think the importance of Side A-only has been overblown point out that Side A-only coverage would not have helped the Enron directors and officers because settlements in that case required that the defendants not be indemnified in any way for certain losses.
Other kinds of liability insurance, including errors and omissions coverage and malpractice coverage, tend to be geared chiefly toward individuals who perform �professional services.� Professional services can be defined as work done for clients that requires special knowledge and is usually associated more with intellectual skills than with physical labor.
In general, errors and omissions coverage or malpractice insurance is useful when professional services do not live up to clients� expectations. Client dissatisfaction may be linked to a contract dispute and a professional�s alleged failure to render a service as promised, or it might be tied to negligence in the performance of services. As it applies to professionals, �negligence� may be defined as the failure to act in a manner that would be suitable for a reasonable person with comparable knowledge and skill.
Like D & O coverage, liability insurance for people who perform professional services will usually cover defense and settlement costs, in addition to court-awarded damages. Some policies may also cover legal expenses when a professional has not been named as a defendant in a legal case but gives a deposition in court.
Just as a D & O policy will probably not shield board chairpersons against liability in their non-board activities, a single errors and omissions policy or malpractice policy will probably not adequately cover a professional who splits his or her time between two dissimilar jobs. Someone who practices law and sells insurance will probably need at least one malpractice policy to cover liability encountered through legal work and at least one errors and omissions policy to cover liability encountered in the insurance business.
When a person has multiple professional roles that are closely related to one another, it may be a bit easier to find desired coverage all in one insurance package. An errors or omissions policy for an insurance agent, for example, might expand coverage so that the agent is also covered when acting as an insurance instructor or as a notary public.
When professionals get their liability insurance through the company they work for, they may only be covered for the liability they face while working for or representing that particular company. In a hypothetical example, independent insurance agents who only have errors and omissions coverage through their business relationship with Insurer X might only be covered by that insurance while representing Insurer X. When they represent Insurer Y, they might either have no protection under Insurer X�s policy or need to pay a steep deductible in order for Insurer X�s coverage to apply at all to their liability with Insurer Y.
Major and perhaps unexpected coverage gaps are also possible if a policy applies only to �professional acts� and uses a very strict definition of that term. For example, one accounting firm�s errors and omissions policy might be broad enough to protect the company and its employees when someone at the firm makes a costly typing error. However, another firm�s policy might exclude claims related to a typing error because the insurance company does not consider data entry to be something that requires a professional�s skill and intellect.
The importance of understanding what is and is not a professional act can be detected in two real-life court cases: Medical Records Associates v. American Empire and PMI Mortgage v. American International.
Medical Records Associates v. American Empire
In the first case, a company was sued for overcharging a client for copies of medical records. After settling the suit with the client, the company demanded that its errors and omissions insurer indemnify it for legal and settlement costs.
In evaluating the insurance dispute, the United States Court of Appeals for the First Circuit noted that errors and omissions coverage is not meant to be an all-encompassing product that covers all of a professional�s risks, said billing was not a professional service offered by the company and determined that clerical-type errors and omissions were not covered by the company�s policy.
According to the court, �Even tasks performed by a professional are not covered if they are �ordinary� activities �achievable by those lacking the relevant professional training and experience.��
PMI Mortgage v. American International
In the PMI case, a company had been sued for allegedly receiving kickbacks in exchange for giving mortgage companies a good deal on their insurance. The suit had been settled for $10 million, with the company�s insurer � AISLIC � having already advanced roughly $1 million to PMI to cover defense costs and other legal expenses.
According to court documents, the AISLIC policy was supposed to cover �the Loss of the Insured arising from a Claim � for any actual or alleged Wrongful Act of any Insured in the rendering or failure to render Professional Services.� �Professional Services� were defined in the policy as �Those services of the Company permitted by law or regulation rendered by an Insured � pursuant to an agreement with the customer or client as long as such service is rendered for or on behalf of a customer or client of the Company: (i) in return for a fee, commission or other compensation � or (ii) without Compensation as long as such non-compensated services are rendered in conjunction with services rendered for Compensation.��
After a court ruled that the settlement costs did not need to be paid by the insurer because the circumstances of the case did not involve professional services, AISLIC filed suit in an attempt to recoup the money it had already advanced to PMI for defense fees and other legal expenses.
From PMI�s point of view, it was at least entitled to the defense benefits. After all, the original suit had centered on an alleged violation of the Real Estate Settlement Procedures Act, a law that applies to professionals in the real estate and mortgage industries. So if the company was being accused of violating a law aimed at professionals, wouldn�t that mean that the suit had indeed involved professional services?
A lower court didn�t think so and said the suit revolved around administrative tasks, but the United States Court of Appeals for the Ninth Circuit felt otherwise. In its opinion, the court said the alleged kickbacks involved clients and professional insurance services and were therefore covered under the AISLIC policy.
In addition to taking different stances on what services and acts should be covered by their various professional liability policies, insurance companies often have their own views as to exactly who should be covered by their products. A doctor�s malpractice insurance might provide some liability protection for nurses who are under the doctor�s supervision or might leave a nurse entirely unprotected.
If a non-professional, such as a clerical worker, commits an error or omission that breeds major economic damages for clients, that person might or might not be covered by a company�s professional liability insurance policy. Consultants at law firms, insurance companies or engineering companies might be insured by a company policy, or they might need to shop for professional liability insurance on their own.
Besides the basic coverage available through D & O insurance, errors and omissions insurance and malpractice insurance, many professionals who run their own businesses believe it is in their best interest to purchase other kinds of liability policies, too.
At least two products � employment practices liability insurance and fiduciary liability insurance � could probably be the focus of a separate insurance course, but they deserve, at least, their own paragraphs in this material because they are often purchased as add-ons to D & O policies or marketed as part of comprehensive insurance products that combine some of the liability insurance features we have already addressed.
Employment Practices Liability Insurance
Employment practices liability insurance pays defense costs, settlements and damages when companies, directors, officers or lower-ranking employees are accused by current, former or prospective employees of violating their rights.
There are several situations that could lead to an employment practices liability claim, such as retaliation (in which an employee complains about an aspect of the workplace and is unfairly punished for speaking up), company monitoring of employees� computer use, sexual harassment and the innumerable chances for discrimination in the hiring, firing and promoting of workers. This broad assortment of liability risks helps make employment practices liability the most frequent source of D & O claims at many private companies and nonprofit organizations.
Policy features, exclusions and premiums may depend on the number of employee-friendly laws in a buyer�s state and on the risks presented by a particular business. When underwriting this coverage, the insurer will probably take the following factors into account:
� The nature of the business being insured
� The number of people being employed at the business
� The business�s history of employment practices claims
� The backgrounds of the individuals that are to be insured by the policy
Coverage under an employment practices liability policy may be contingent on employees completing a training program that educates them about workplace issues.
Under the Employee Retirement Income Security Act of 1974 (ERISA), benefit plan administrators can be held personally liable for their mistakes. In addition to other plan concerns, company officials risk being sued by current employees, former employees and families if they make investment decisions that have a negative impact on benefits. They also could face trouble if the fees employees must pay in order to be covered by a plan are not considered reasonable.
On its own, a D & O policy usually does not cover ERISA claims, but �fiduciary liability insurance� can be bought in conjunction with a D & O policy to guard against these risks. Like the other policies we have addressed in this chapter, fiduciary liability insurance can cover defense costs, settlements and damages. Insured parties may include a company, its directors and officers and past, present and future plan administrators.
Fiduciary liability insurance is sometimes packaged with �employee benefit liability insurance,� which addresses similar risks but does not cover ERISA claims. An employee benefit liability policy might cover claims in which a plan administrator either made errors that prevented an employee from joining a plan or gave employees the wrong impression of what benefits were available through a plan.
A professional liability policy � be it an errors and omissions contract, a D & O contract or a malpractice contract � will probably cover valid claims for one year before needing to be renewed by mutual consent of the policyholder and the carrier. But, as is the case with many other insurance products, the fact that a claim is valid under the policy language hardly exempts the policyholder from having to pay any portion of that claim.
Insureds should expect to pay deductibles and co-payments, which let the insurance company take some of the financial risk off its own shoulders and give it back to clients. The �deductible� is the amount, expressed in dollars, which policyholders must pay on their own before an insurance company applies policy benefits to a claim.
No matter the type of professional liability policy, the deductible is unlikely to be small. Deductibles for errors and omissions and malpractice policies can be in the thousands, and a few D & O deductibles have been higher than $1 million.
Producers can negotiate with carriers in order to arrive at a deductible that reflects the buyer�s risk tolerance and financial resources. In exchange for a lower deductible, the buyer will usually pay higher premiums. In exchange for lower premiums, the buyer will have to take on more risk by agreeing to a higher deductible.
The deductible in a professional liability policy can be applied in a number of different ways. A policy might call for a one-time aggregate deductible of $1,000, for example, while another policy might call for a $1,000 deductible on each claim filed during the policy�s term.
A per-claim deductible, which tends to shelter the insurer from numerous small claims, does not need to be entirely inflexible. Related claims can be grouped together for the sake of the deductible. It is even possible to combine claims from a civil suit and claims from a criminal proceeding if all claims stemmed from the same error, omission or negligent act.
A professional liability policy might make exceptions for certain claims and require the policy�s owner to pay no deductible at all in those cases. For instance, some but not all policies impose a deductible upon settlements and damages, while applying consumer-friendly, first-dollar coverage to defense costs. This approach protects insureds from having to lose money as the result of frivolous lawsuits.
As we noted earlier, a D & O policy might have no deductible for Side A claims but require deductibles to be met for Side B claims and Side C claims. D & O policies may also have one deductible for claims involving an individual director or officer and another deductible for claims involving two or more directors or officers.
In addition to a deductible, professional liability policies might list a �co-payment,� which requires the insured to pay a portion of all claims even after a deductible has been satisfied. For example, a policy might require an insurer to pay 95 percent of each claim after a deductible has been met and require the insured to pay the remaining 5 percent.
When big or frequent liability claims arise, it will be important for insureds to know how close they are to reaching their benefit limit. A policy might have a �per-claim benefit limit� that caps coverage on each claim or an �aggregate benefit limit� that suspends coverage when total claims during a coverage period reach a certain dollar amount. A policy may have both a per-claim benefit limit and an aggregate benefit limit.
Like a deductible, a benefit limit might not apply to all kinds of claims. Buyers who are worried that expensive defense costs might erode their coverage and leave them with few benefits for settlements can shop around for a professional liability policy that excludes defense costs from benefit limits.
A wide range of benefit limits are common in the professional liability market. Sales professionals report that an insurance agent can have anywhere from $500,000 to several million dollars in errors and omissions coverage. Architects typically protect themselves with at least $1 million in liability insurance, and D & O policies often max-out somewhere in the neighborhood of $10 million.
In actuality, companies or professionals can probably snare as much liability insurance as they feel is necessary. To get it, they just need to be prepared to work with multiple insurers.
Many professionals buy policies from multiple carriers and construct high �towers� of coverage. At the base of a tower is the primary insurance policy, which is likely to be affected whenever an insured files a claim. Supplemental policies are stacked on top of the primary insurance policy and are put to work when benefits under the primary policy have been exhausted. When benefits under the primary policy and a supplemental policy have reached their limits, coverage under the next policy in a tower can kick in.
Insurance brokers are deeply involved in assembling towers of coverage for companies and are often responsible for ensuring that the multiple policies from multiple insurers fit together without leaving coverage gaps.
At first, layering policy upon policy might seem like an expensive approach to risk management. Though this financial assessment is probably true in many cases, buyers should remember that, at some point in a tower, higher levels of coverage start to become considerably less expensive. This eventual drop or leveling in price occurs when the probable size of a claim is highly unlikely to affect the upper portion of an insured�s tower.
Whether a person or company is planning to buy a new professional liability insurance policy or is hoping to renew an existing contract, price is certain to be a concern. Like all other kinds of insurance, professional liability coverage is priced based on the various risks that an insured party presents to an insurance company. When underwriting a candidate for professional liability insurance, a carrier must take into account not only the probable frequency of claims but also the probable size of those claims.
For obvious reasons, a client�s claims history and legal history will have a significant effect on the way a carrier views the client�s risk potential. A history of claims from an old policy could jeopardize the client�s chances of getting a new policy at a desired price, and claims on an existing policy could lead to trouble at renewal time. Claims or no claims, the insurer will probably be interested to know if the client has been sued and, if so, under what circumstances.
A spotless history, however, is sometimes not all a client needs to receive preferred premiums and benefits. After all, a law-abiding, ethically upright client can sometimes be named in a suit, and shady clients can get lucky and avoid having to go to court for years on end. To minimize the luck factor, an insurer may ask new or renewing clients about the safeguards they have put in place to keep claims at a minimum.
The client�s experience level can also have an effect on premiums. Like a newly licensed driver applying for auto insurance, freshly licensed insurance producers might need to wait a few years before they become eligible for less expensive errors and omissions coverage.
The price for policies will often depend on the specifics of the services that are provided by the insured. Premiums for legal malpractice coverage may depend on the area of law that an attorney practices. Likewise, doctors in one line of medicine will pay different rates than physicians with other specialties.
If an individual has a specialty within a profession, the insurer might base part of a premium on how often the person ventures outside of that specialty to perform services. For example, a design professional who focuses strictly on environmental engineering might be able to get a better rate than someone who works as a structural engineer and as an environmental engineer.
Regardless of the risks that an applicant presents to an insurer, a professional liability policy may have a minimum premium that must be paid in full before coverage begins.
Once companies and professionals have secured a professional liability policy and coverage has begun, their next concern will be how to deal with claims made against the insurance.
First and foremost, covered individuals ought to have a clear understanding of what constitutes a �claim� under their contract. In general, a claim is a demand for money from the insurance company, but policy language can contain a definition that is much less or much more specific than that. At its most formal, a claim can be a professionally prepared legal document. At its most informal, a claim may be a verbal demand for damages.
Based on the way they handle claims, insurance contracts can be deemed either �claims-made policies� or �occurrence policies.�
Claims-made policies cover claims that arise during the applicable coverage period. If damage is done during the coverage period but a person waits until after the coverage period to make a claim, the insurance company can deny the claim.
On the other hand, a claim on an occurrence policy can be made at any time, as long as the damage that provoked the claim was done during the coverage period.
As an example, think of a doctor who performed surgery on a patient in 2006 and was sued yesterday for performing the surgery in a negligent manner. Then pretend that the doctor had left the medical profession at the end of 2006 and did not renew his malpractice insurance. If the doctor�s insurance was written on a claims-made basis, he might not be covered at all and need to pay out of pocket to defend himself. However, he might still have coverage if his insurance was written on an occurrence basis, since coverage under an occurrence policy depends on when the alleged wrongdoing took place and does not depend on the timing of a claim.
Pros and Cons of Occurrence Policies
Some experts in their fields advise their fellow professionals to buy an occurrence policy if one is made available to them. The coverage is broader than claims-made coverage and puts less pressure on insureds to report claims quickly. But occurrence policies have their drawbacks.
The reduction in time sensitivity can give insureds a false sense of security and make them think that their coverage for past errors lasts forever. In reality, each occurrence policy � like any other kind of insurance � only provides benefits up to a certain dollar amount. If previous claims have exhausted policy benefits, an otherwise valid claim can be denied by the insurance company.
Occurrence policies also tend to be more expensive than claims-made policies because the policies� benefits can last longer. With an occurrence policy, an insurance company is obligated to pay claims after cancellation and therefore absorbs risks for a longer period of time. Conversely, insurers can charge less for a claims-made policy because they do not need to honor claims after a cancellation, unless the policyholder opts for extended coverage and pays an additional fee.
Particularly in regard to professional liability, determining coverage under an occurrence policy can be challenging for an insurer. While other kinds of insurance claims (such as property claims under fire or auto policies) can be easily traced to a specific event that occurred on a specific date, insurers may struggle to determine exactly when an error, omission or an instance of professional negligence took place. Because an insurer cannot count on a professional to always document errors in judgment as they occur, insurance companies may find it easier to offer professional liability insurance through claims-made policies.
For various reasons, occurrence policies for professional liability insurance are far less common today than they were in years past. In fact, �media liability insurance� may be the only kind of liability coverage that a modern-day insurer will provide customarily on an occurrence basis. This insurance, which protects insureds against claims involving libel and slander, is different compared to the other kinds of coverage we have addressed thus far, in that a media liability claim can almost always be traced back to a specific event that occurred on a specific date. Libel can be traced back to the date when the allegedly libelous comments were published, and slander can be traced back to the date when the allegedly slanderous comments were spoken to the public.
Most D & O, errors and omissions and malpractice insurance contracts are claims-made policies. These polices can make the timely reporting of claims more important than many insureds realize. In fact, it is not uncommon for an otherwise valid claim to be denied by an insurer all because a policyholder did not report it promptly to the carrier.
For clarity purposes, �reporting� a potential or real claim may be defined as communicating with the insurer about the claim in a reasonable way. It is advisable and sometimes necessary for insureds to report not only the existence of a claim but also the potential for a claim as soon as possible.
The demands made on a policyholder to report potential claims comprise what is sometimes known as a �notice of circumstance.� Depending on the policy, an insured might need to provide notice of circumstance within 60 to 90 days of knowing about a potential claim.
Still, an insurer�s strict attitude toward the reporting of claims can occasionally work in the consumer�s favor. Among the claims-made policies that require insureds to give notice of potential claims, a few make it possible for policyholders to report potential claims, cancel their coverage and still be covered for defense and settlement costs if a real claim arises at a later date.
Like all kinds of claims-made policies, liability insurance for professionals can have major gaps near the beginning and the end of coverage periods. Most of these policies contain some kind of �prior acts exclusion,� which excuses the insurer from having to cover claims when an insured�s error, omission or negligent behavior occurred before the liability insurance took effect.
Suppose an uninsured insurance agent works with clients and performs his duties negligently. Then, before the affected clients become aware of the negligence, the agent buys an errors and omissions policy for himself. Two months later, a client realizes she has been wronged and files suit against the agent. The opposing parties work out a settlement, and claims are then filed with the agent�s insurance company. Although the claims are made within the coverage period, the insurer is able to deny the claim because the negligence leading up to the claim occurred before the agent bought his policy.
Many insurance companies offer �nose coverage,� which protects insureds when a claim occurs during a coverage period but the error, omission or negligence occurred before the coverage period. In other words, nose coverage can handle claims that would otherwise be denied on the basis of a prior acts exclusion.
Nose coverage is often bought when a client switches from a claims-made policy to an occurrence policy, but it can also be bought by people who are replacing one claims-made policy with another and by people who have never had any form of professional liability insurance. Nose coverage is not necessary if a client is replacing an occurrence policy, since prior acts excluded by a new claims-made or occurrence policy are likely to be covered under a lapsed or cancelled occurrence policy.
The extent of an insured�s nose coverage depends on a �retroactive date.� When a claim arises and the related act was committed on or after the retroactive date, the nose coverage kicks in and protects the insured. When a claim arises and the related act was committed before the retroactive date, the insured is not protected by the nose coverage.
If the buyer purchases nose coverage from the start, the policy�s retroactive date will typically not change when the client renews coverage. If the buyer does not purchase nose coverage from the start, renewed policies will have a retroactive date that reaches as far back as the day coverage originally began.
So, in spite of the typical one-year coverage period for most professional liability policies, someone who bought a policy on Jan. 1, 2008 will continue to be covered for acts committed on and after that date in subsequent years, as long as the policyholder pays premiums on time and renews the insurance consistently.
When companies or individuals purchase a new claims-made liability policy instead of renewing an old one, they can arrange for nose coverage to retroactively date back to the first day of coverage under the old policy. If clients have never had a professional liability policy, the insurer can arrange for nose coverage that dates back to the day a company or individual first started providing professional services.
�Tail coverage� can be an alternative to nose coverage if a client is replacing a claims-made policy or has no intention of renewing or replacing a claims-made policy. Tail coverage gives insureds an �extended reporting period,� which allows clients to report professional liability claims and have them covered even if coverage has otherwise been cancelled or has expired. This coverage does not apply to errors, omissions or negligent acts that occur after a policy has been cancelled, but it does protect former policyholders when an act that was committed during the policy period creates legal problems in the present.
Perhaps the easiest way to understand how tail coverage works is to think of a retired professional. Pretend an attorney retired at the end of 2007 and chose not to renew her malpractice insurance for 2008. In 2008, a former client sued the attorney for negligence, claiming that she had an improper and damaging effect on a court case. Although the attorney cancelled her insurance coverage in 2007, her defense costs and other legal expenses might still be paid for by her old insurer if she had purchased tail coverage.
Insurers are often required to offer tail coverage to insureds when liability insurance is cancelled or not renewed. Exceptions to this requirement might include cases in which a policyholder has not paid premiums or has misrepresented facts to the insurance company. Research conducted for this course showed that tail coverage often lasts within the range of three to six years, though coverage of one year is not unheard of and coverage over an insured�s lifetime may be possible.
An insured usually has a month or two to consider an offer for tail coverage and can accept the offer by paying for the coverage with a lump sum. The premium for tail coverage is typically based on the price of liability insurance during the old policy�s final year. The lawyer in the preceding example, for instance, would have probably paid a tail premium equal to her 2007 annual premium, multiplied by 100 percent, 150 percent or some higher percentage. An insurer may provide discounted tail coverage to clients who are canceling their policies due to retirement or disability.
It should be noted that many people use the terms �tail coverage,� �extended reporting period� and �discovery period� interchangeably, while others use these phrases to mean slightly different things. To some producers, a �discovery period� is a short-term extended reporting period that is included within a professional liability policy at little or no charge. These producers may reserve the term �tail coverage� for longer and pricier extended reporting periods that the insurer sometimes offers to clients at its own discretion.
When companies protect their directors, officers and various employees through a corporate-bought liability policy, it is important for insureds to understand how coverage may be affected by their organization�s business decisions and financial health.
Coverage in the event of a merger or acquisition will depend on policy language. A newly acquired company might have temporary tail coverage through its own insurer or might be covered temporarily through the new parent company�s policy.
Bankruptcies can be a problem for anyone at a failing company but present specific insurance problems for directors and officers. As was mentioned earlier, entity coverage under Side C of a D & O policy can make the coverage property of the company. When deemed company assets by a court, D & O insurance benefits may be frozen, leaving individual directors and officers to pay their own legal expenses until various financial knots can be untangled. In order to evaluate their exposure to this potential gap in coverage, directors and officers may want to find out if their company has purchased Side A-only insurance.
Even careful and ethical professionals may have to defend themselves against charges of negligence, malpractice or some other alleged misdeed, and even a suit that leads to a dismissal or a �not guilty� verdict can be an extremely expensive distraction for the accused. On its own, the cost of defending oneself against bogus charges can equal thousands of dollars, or perhaps even more if a person employs top-notch representation in a drawn-out court case. With the price of pleading their innocence often running so high, many companies and individuals place as much importance on a policy�s ability to absorb defense costs as they do on its ability to cover settlements and court-awarded damages.
Almost all D & O policies, errors and omissions policies and malpractice policies force an insurer to pay defense costs when a suit involves an act or risk that is covered under the insurance contract. Once it begins paying these costs, the insurer generally cannot suspend payments unless it can conclusively show that the suit does not involve a covered act or can conclusively show that it is within its rights to cancel coverage.
Though insured persons can take comfort in knowing that their policy will help them pay for legal fees under several circumstances, they should not ignore the limitations and particulars of their contract�s defense provisions. Unlike many forms of general liability insurance, the kinds of insurance we have focused on in these pages usually apply defense costs to policy limits. In other words, if an insurance agent is covered by a $500,000 errors and omissions policy and his insurer pays out $500,000 for defense costs, there will be no money left over to cover settlements, court-awarded damages or any other claims. It is also important to remember that an insured may need to pay for some defense costs out of pocket until a policy�s deductible has been satisfied.
When a suit is filed against an insured, the professional�s relationship with a carrier will depend on whether the policy puts a �duty to defend� upon the insurance company�s shoulders. When a policy creates a duty to defend, the insurance company is responsible for contesting claims with plaintiffs. This responsibility can give the insurer immense control over the defense process. In cases in which a duty to defend exists, the insurer can choose the defense team that will be entrusted with handling the suit, or it can pre-approve a list of legal professionals and require a client to choose defense counsel from that list. A duty to defend can also give an insurer the power to approve defense strategies.
Many liability policies for professionals and high-ranking corporate officials do not create a duty to defend. However, the absence of a duty to defend does not allow an insurer to avoid paying defense costs, and it does not completely eliminate an insurer�s power over the defense process.
A professional liability insurer without a duty to defend cannot force legal counsel upon a defendant, but it may still have the right to veto the insured�s choice for representation. After a defense team has been put in place, the insurer can refuse to pay attorneys� fees if the services being provided by the defense team or the costs of those services are not considered reasonable. From a procedural standpoint, an insurer without a duty to defend may still require that an insured�s lawyers work on an hourly basis and keep an accurate record of the time they spend performing various tasks. Regardless of a policy�s aggregate benefit limit, the insurance contract can impose a per-hour cap on reimbursable attorneys� fees.
Even without a duty to defend, the insurer often must be kept in the loop throughout the stages of a case so that it can evaluate the size of potential claims and get an idea of when a court decision or settlement might be forthcoming.
Due to the huge expenses involved with defending oneself in a lawsuit, it will be important for professional liability clients to know when they can expect to receive reimbursements for defense costs. Policy benefits that cover defense costs can either be advanced to defendants when a lawsuit is filed, or they can be paid to insureds at a later date after legal services have already been rendered.
Nearly every insurance customer would probably prefer to receive money for defense costs as an advance, since this kind of arrangement puts less economic stress on the insured and can give an innocent professional more courage to refute a plaintiff�s charges. If defendants need to bankroll their own defense before benefits arrive, they may worry about not having enough personal assets to pay for their immediate expenses and could end up accepting an unfavorable settlement out of desperation. If clients can get an advance from their insurer for legal expenses, they may be more likely to hold out for a fairer settlement or seek an appeal of a court�s unfavorable ruling.
Many insurers will advance some defense money to their clients, perhaps operating under the assumption that clients are innocent until proven guilty. But some guilty verdicts, such as those pertaining to fraud, can lead an insurer to rescind its generosity and require the insured to return the advanced funds.
The possibility that an insurer may demand repayment of defense costs is often articulated in a �reservation of rights letter,� which is sent to an insured by the carrier if the validity of a claim is uncertain. Through this notice, the insurer informs the insured that it will give the person the benefit of the doubt and cover defense costs related to a questionable claim. Yet if the company later determines that the claim should not be covered under the policy for any reason, the reservation of rights allows the insurer to stop paying defense costs, deny coverage of any eventual settlement or court-awarded damages and possibly recoup insurance money from the client.
With all the exciting courtroom drama that can be found on television shows, in movies and in popular fiction, it can be easy for people outside the legal profession to forget that a huge number of lawsuits don�t go on long enough to merit a final verdict from a jury or judge.
Defendants may have several reasons to prefer a settlement over continued court proceedings, and many of those reasons have little to do with the accused actually being at fault. For one, the judicial process can be very tedious, with people on both sides of a suit often waiting several years for a final verdict. As more and more money, energy, worry and patience is invested in a case, defendants might believe it is in their best economic, physical and emotional interests to put an end to all the legal fighting and get on with their lives.
Sometimes, too, innocent defendants check their emotions at the door, take a step back from their situations and recognize that, for whatever reason, a judgment in their favor is highly unlikely. Perhaps a professional�s defense is too packed with jargon and technical know-how for a jury of laypersons to sympathize with. A medical malpractice case, for example, might hinge on a complex anatomical issue, while a corporate director�s defense in a liability case might be linked to a dry and complicated securities law.
Or maybe the professional is tempted to settle a suit because a court�s harsh verdict could put the person�s financial health in serious danger. When a court is likely to award damages to a plaintiff that are in excess of a defendant�s insurance benefits, the defendant�s legal team will probably level with its client and recommend settling the suit.
Though liability insurers and their clients can benefit from settling certain claims a carrier and an insured may become annoyed with each other when one of them wants to settle a case and the other wants to fight it. Luckily for each of them, many professional liability insurers recognize the potential for tension and address this issue in their policies so that both sides may understand their rights.
If a client wants to settle a suit against an insurer�s wishes, the insurer cannot prevent a settlement from taking place. It makes no difference if the insurer suspects that the client committed fraud or some other wrongful act and is hoping to use a court�s final ruling as grounds for denying a claim or rescinding coverage altogether. Clients just need to give notice to their insurer when they are prepared to settle with plaintiffs. Similar notification will be necessary if a client intends to admit guilt in a case in the hope of receiving a lighter sentence.
Often, the insurer is the one that wants to settle, and a client is the one who wants to prolong a legal dispute. When this occurs, many liability policies purchased from non-admitted carriers put the policyholder at the mercy of the insurer and let the carrier settle a case on its own. Other policies feature a �consent to settle clause� and require that the client approve a proposed settlement before it can be executed.
A consent to settle clause might only let the client give a �yes� or �no� response to a proposed settlement, while leaving the person in the dark about the size and particulars of the deal. In most forms, a consent to settle clause is only relevant if a client�s refusal to settle is reasonable. Otherwise, an insurance company may be able to settle with a plaintiff without the policyholder�s approval.
Other pieces of a professional liability policy respect an insurer�s desire to settle claims but allow clients to continue fighting a lawsuit if they so choose.
When a client does not consent to a proposed settlement, the insurance company can invoke a policy�s �hammer clause.� A hammer clause basically states that the insurer will cover a liability claim equal to the amount of a proposed settlement and will deny any liability claim that is in excess of that amount.
Suppose an attorney was sued for malpractice and that the plaintiff was originally willing to settle the case for $500,000. The attorney did not agree to the deal, and his insurer invoked his policy�s hammer clause. If the attorney ends up losing his case and is required to pay the plaintiff $500,000 or less, he may be able to have his claim covered nearly in full by his insurer. However, if he loses and must pay $1 million to the plaintiff, he will need to pay at least $500,000 out of his own pocket.
Some hammer clauses only make the insured responsible for paying excessive damages and excessive settlements, while keeping coverage of defense costs intact. Others can introduce limits on defense benefits.
It�s also possible for a policy to contain a �soft hammer clause,� which splits the responsibility for paying excessive claims between the insurer and the client. By invoking a soft hammer clause, the insurer might agree to pay claims equal to a proposed settlement and cover 50 percent of claims above that amount.
A few policies contain �carrot clauses,� which do not penalize clients for turning down a settlement but give them a positive incentive to accept one. For instance, under a carrot clause, clients might be able to reduce their deductible if they agree to settle a suit early.
An insurer�s responsibility to pay liability claims can get complicated when a lawsuit names two or more defendants. If one defendant is covered by a policy and another defendant is not covered by a policy, should the insurer have to pay all legal fees related to the case, or should it only pay a portion of them? What about cases in which all defendants are covered by a policy? Should one insured�s claim take precedence over another insured�s claim?
All these questions relate to an issue called �allocation,� which involves how benefits from a single policy are distributed to multiple parties. Allocation is particularly important for people who are insured by D & O policies, because shareholders, employees and other common plaintiffs in D & O cases often file charges against individuals and companies via the same suit.
There appears to be no strict standard that D & O insurers apply to allocation situations, but we can still address possible courses of action in a general manner. As a general rule, a D & O insurer will cover defense costs for an uninsured individual when the same legal services are provided to an insured individual at no additional cost. However, if an attorney performs a service specifically for the uninsured defendant, the cost of that service will not be covered by the insurance company.
A similar rule tends to apply when a single insured is sued for some acts that are covered by a policy and some acts that are not covered by a policy. The insurer will likely pay the cost of defending the covered portion of a claim, while making the defendant responsible for the uncovered portion of a claim.
When a company is sued along with a director and officer, a D & O insurer may rely on a �priority of payments clause� to determine who should be the first to receive policy benefits. Usually, a priority of payments clause favors an individual director or officer over a company. Claims made against Side A of the policy tend to be paid first, followed by claims made against Side B. Claims related to entity coverage (Side C) are typically last in line, making it less probable that a claim against the company will erode benefits for individuals.
Bear in mind, however, that the priority of payments clause may only apply to actual claims and not to potential claims. So if the insurer expects a claim under Side A of a policy and has actual claims that factor into sides B and C, the insurer might be able to go ahead and pay the B and C claims without needing to wait on the A claim.
As helpful as D & O policies, errors and omissions policies and malpractice policies can be for clients, they do tend to contain many exclusions.
It is best for a client to understand these exclusions before a claim arises. When an insurance professional discloses and explains policy exclusions to a buyer early in their relationship, the client has more time to fill in coverage gaps, and the potential for coverage disputes is reduced.
The next few pages highlight many of the exclusions that apply to various liability policies. Though readers should note that many of the mentioned exclusions are reserved for specific groups of professionals, there is also some occasional overlap.
All the professional liability policies discussed in this text tend to exclude coverage of perils and events that can be covered by another kind of insurance policy. Claims for property damage and bodily injury may be covered by a company�s general liability insurance, so a professional liability policy is unlikely to pay such claims. Product liability insurance is its own product and is also excluded from professional liability contracts. The same is true for insurance that protects companies and individuals who are accused of slander or libel.
It may be possible for a company to purchase all these other kinds of insurance from the same carrier as part of a package that also includes professional liability coverage or D & O coverage.
D & O insurance policies contain �conduct exclusions,� which allow an insurer to deny a claim if it was caused by an insured who acted extremely improperly in the course of his or her duties. The most popular conduct exclusion in a D & O policy gives the insurer the right to deny a claim if the insured has committed fraud by withholding information or misrepresenting facts to people who deserved to know the truth.
From the buyer�s perspective, the policy should allow an insurer to deny claims on the basis of fraud only when the fraud has been conclusively proven. Without this kind of limit in place, the insurer could deny claims, including defense costs, when a plaintiff accuses an insured of fraud without having sufficient evidence to back up the charge.
Depending on the policy, an insurer can deny a D & O claim when there has been either �fraud in fact�� or a �final adjudication� of fraud by a court. Since exploring the nuanced definition of �fraud in fact� would probably steer this text off course, suffice it to say that an exclusion of �fraud in fact� can give the insurer a better chance of denying a claim.
An exclusion based on a final adjudication is simpler to understand and is probably more beneficial to the insured. When a fraud exclusion is contingent upon final adjudication, the insurer must pay all claims, including those for defense costs, until a court rules that the insured committed fraud and does not have its ruling overturned on appeal. In other words, this kind of fraud exclusion allows someone who has been accused of fraud to have defense costs covered until the end of a case.
Another common conduct exclusion in D & O policies prevents the insured from receiving insurance benefits if a court rules that the person has profited illegally through misdeeds. This exclusion closes a loophole that would otherwise allow a financial criminal to suffer no losses when there is a court-ordered �disgorgement of funds.� A disgorgement of funds occurs when someone surrenders ill-gotten gains and returns them to wronged parties. This exclusion is often an issue when a case involves backdating of stock or insider trading.
In an effort to prevent policyholders from using their insurance coverage as an instrument of fraud, many liability contracts contain an �insured vs. insured exclusion.� This exclusion lets the insurance company deny claims when the opposing parties in a lawsuit are covered by the same policy. This exclusion is most commonly an issue for directors and officers (who will not have coverage if they are sued by their own companies), but it occasionally applies to non-corporate professionals, too. A medical malpractice policy that covers a doctor and his nurse, for instance, might not provide benefits to the doctor if he performs a medical procedure on the nurse and is sued for negligence.
The insured vs. insured exclusion can be broader than its name suggests. It may exclude coverage when a legal battle is waged between a person who is covered by a policy and a relative of someone who is covered by that same policy. Regardless of any familial relationship between them, a wannabe plaintiff cannot work around the insured vs. insured exclusion by asking or encouraging a third party to sue an insured. A suit by a shareholder against a director or officer, for example, will not be covered by a D & O insurer, unless the shareholder takes legal action independently, rather than in connection with the corporation or some other covered entity.
For clarity�s sake, companies may want to learn how their D & O coverage would be affected if the company ever fails and is taken over by a regulatory body. Would the regulator then be thought of as �the company� by the insurer and be treated as an insured under the policy? If so, would the company�s directors and officers be covered if the regulator sued them?
Side A-only coverage, which is reserved for individual directors and officers, sometimes has a modified insured vs. insured exclusion, letting the insurer deny claims when directors and officers are sued by their own companies but allowing coverage for suits between two or more individual insureds.
When a company or an individual faces a civil suit that relates to his or her job duties, internal and regulatory investigations are often not far behind. A shareholder suit against a director or officer might prompt a board of directors to form a committee to investigate the merits of the legal claim, and entities such as the SEC might weigh in on the matter. In similar fashion, a malpractice suit against a doctor might lead to a situation in which the physician must defend himself or herself to a state medical board in order to keep a license in force.
Coverage in these situations is far from uniform across the liability insurance community. An individual or company that is in the market for liability insurance might find that some policies will not cover claims arising out of self-initiated investigations or informal investigations conducted by regulatory bodies. Older D & O policies, including those that were issued near the passage of the Sarbanes-Oxley Act, excluded coverage of some specific SEC-related claims while covering policyholders in other kinds of securities disputes.
When they exist, exclusions that pertain to regulatory actions can apply to fines, penalties, punitive damages or seemingly any other kind of demand for money.
Several liability policies specifically exclude coverage for pollution claims. This exclusion can create a big insurance gap for design professionals who may have worked with lead-based paint or are linked to an asbestos problem. Corporate executives are also affected by this exclusion when their companies produce products that harm the environment or perform services that create pollution.
In many cases, this gap can be eliminated through the purchase of an �environmental insurance policy,� which can cover the cost of cleanups and the consequences of hazardous spills. Many companies, however, do not buy this coverage and fail to realize that even a securities claim, which would normally be covered by a D & O policy, can be denied if there is a significant connection between shareholders� losses and a pollution problem. The cases National Union Fire Insurance Co. v. U.S. Liquids, Inc. and Owens Corning v. National Union Fire Insurance Co. exemplify different courts� interpretations of pollution exclusions.
National Union v. U.S. Liquids
U.S. Liquids was a waste disposal company that, at some point, had acquired City Environmental Inc., a Detroit-based business that was dumping waste illegally into the city�s sewer system and was being accused of other environmental violations. The eventual closure of a City Environmental plant by the Environmental Protection Agency led to a criminal investigation of U.S. Liquids, a six-day suspension of trading for company stock and a nearly $10.75 decline in the value of the company�s securities.
Shareholder and derivative suits against U.S. Liquids collectively charged that the company had violated fiduciary duties, falsified environmental test results and inflated its earnings by charging people for disposal services that were never completed. From the company�s point of view, its legal problems were not about pollution; rather, they centered on fiduciary responsibilities, omissions and misrepresentations. It was therefore assumed that the company�s D & O insurer would at least pick up defense costs related to the suits.
Though the insurer agreed that U.S. Liquids� claims were indeed securities claims, it still invoked the policy�s pollution exclusion, which applied to any loss in connection with a claim �alleging, arising out of, based upon, attributable to, or in any way involving directly or indirectly the actual, alleged or threatened discharge, dispersal, release or escape of pollutants; or any direction or request to test for, monitor, clean up, remove, contain, treat detoxify or neutralize pollutants, included but not limited to a Claim alleging damage to the Company or its securities holders.� The company�s policy also said pollutants �include (but are not limited to) any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.�
To the United States District Court for the Southern District of Texas, the pollution exclusion was �broad� and �clear,� and the company�s problems with misrepresentations and pollution were �not mutually exclusive.� The court sided with the insurer, ruling that the carrier had neither a duty to defend U.S. Liquids� claims nor a duty to indemnify the company for its losses.
That decision did not sit well with lawyers for U.S. Liquids, who claimed that such a ruling could effectively void all security coverage under the policy, since dealing with pollutants was an essential part of the company�s business. The court, however, refuted that interpretation of its ruling, saying that its decision would still leave enough room for the policy to cover securities claims if they were connected to self-dealing, tax evasion or embezzlement.
Owens Corning v. National Union
A court that heard the Owens Corning case arrived at a different conclusion. Problems at Owens Corning had resulted in shareholders filing a class action suit against the company, alleging that the company had withheld information about its exposure to asbestos risks and misjudged the effect a major asbestos claim would have on the organization�s finances. Assorted misrepresentations, according to shareholders, had artificially inflated the company�s stock.
The class action case was settled, and the company indemnified its directors and officers for their losses. But when the company tried to collect from its D & O insurer, the carrier denied claims on multiple occasions, citing a policy exclusion. Policy language left the company uninsured for �any claim � arising out of or related to asbestos or asbestos related injury or damage; or any alleged act, error, omission or duty involving asbestos its use, exposure presence existence, detection, removal, elimination or avoidance��
Following a temporary victory for the insurer via another court, the United States Court of Appeals for the Sixth Circuit ruled that it was the company�s alleged misrepresentations that had inflated its stock, and not the asbestos. The central issue in the case, from the court�s perspective, was not asbestos. Instead, it was the manner in which the company had represented its financial health to the plaintiffs. In contrast to the court in U.S. Liquids, the Owens Corning court reasoned that allowing the insurer to deny the claim based on an asbestos exclusion could potentially leave the company uninsured against all kinds of shareholder suits, since it made its money by selling asbestos products.
Cultural changes and current events make insurers� use of pollution exclusions something to keep an eye on. Scientists, politicians, news outlets and the general public have heaped tremendous amounts of attention on the issue of global warming in recent years, and it may be just a matter of time before many companies are pulled into court due to their alleged roles in climate change. Yet even within the large faction that does not doubt climate change is a real problem, there is a debate as to whether greenhouse gas (a main culprit in climate change) is technically a pollutant in the traditional sense of the word.
With that in mind, it will be interesting to see how liability insurers respond. Will they be able to deny global warming claims through their preexisting pollution exclusions, or will they add specific language to the policies in order to protect themselves?
At this point, one may even predict that the industry will respond to global warming in much of the same way that some insurers responded to terrorism in 21st century: by working around policy exclusions and creating a product that meets clients� modern needs.
Business is more international than ever before, with U.S. companies commonly conducting business with clients and peers in other countries, and with American corporations expanding their reach by opening offices all over the globe. This globalization presents both obvious and sometimes overlooked challenges to directors, officers and various professionals.
Among the less obvious complications is the effect international business can have on a person�s liability insurance. If an individual or company has a D & O policy or an errors and omissions policy, the coverage may only extend to domestic claims and not to international disputes. So the insured may not be able to access any insurance benefits from a U.S. carrier if a lawsuit is filed outside of the United States.
If a policy does not specifically exclude international claims, the insured should still keep in mind that a U.S.-based company with overseas offices may need to comply with foreign insurance laws. D & O benefits, for instance, may not be available to directors and officers who are stationed overseas unless the company has purchased coverage from an overseas carrier. D & O insurance contracts that cover companies and individuals beyond U.S. borders may need to be written in foreign languages, which may create a problem if something is lost in translation.
Finally, it is worth mentioning that some countries put limits on a company�s ability to indemnify its directors, officers and other employees for legal expenses. Years ago in the United Kingdom, for example, indemnification was not allowed if a case was settled out of court.
Other exclusions have received less attention from the people who sell insurance and the people who write about the industry. Admittedly, some of the lesser-known exclusions are only applicable to specific kinds of clients. However, since producers are likely to encounter a broad variety of professionals in need of liability protection, it is important for them to at least be aware that these various exclusions exist.
A D & O policy, errors and omissions policy or malpractice policy may or may not cover the following:
� Punitive damages
� Taxes
� Privacy breaches
� Discrimination claims
� Cases in which a company is sued for not having bought adequate insurance
� Cases in which an insurance producer inappropriately gave clients tax advice
� Cases in which an insurance producer participated in bid-rigging, rebating or wet-ink transactions
� Cases in which insurance producers failed to disclose the duties they owe and do not owe to clients as agents or brokers
� Cases in which directors and officers are accused of violating the Employee Retirement Income Security Act
� Cases in which medical professionals gave free advice or provided free services and are accused of malpractice
In addition to having the right to deny a specific claim, a liability insurer reserves the right to �rescind,� or revoke, an entire liability policy under certain circumstances.
Grounds for rescission are few, making this total cancellation of coverage relatively rare. An insurance company may rescind a professional liability policy when the policyholder fails to pay the required premiums on time or when it is determined that the filled-out application for the insurance contained untruths.
The insurer�s ability to cancel coverage in these situations probably seems reasonable enough to most people. Insurance companies do not want to give coverage away for nothing, and they do not want to be misled about the nature of the risks that they undertake.
Still, the insurer�s right to rescission is not as clean-cut as it may seem, particularly when it comes to untrue statements on an insurance application. When an insurance company wishes to rescind a policy due to an applicant�s misrepresentations, the burden of proof is on the insurance company. In other words, the applicant is considered innocent until proven guilty and remains covered until the insurer can conclusively show that misrepresentations occurred.
An insurer may not be able to rescind a policy, regardless of a misrepresentation, if the insurer should have reasonably known about the misrepresentation when it was made or if the misrepresentation did not influence the way the insurer offered coverage to the applicant. When an insurer is successful in rescinding a policy, it typically must give affected policyholders a refund of their premiums.
Directors and officers should be made to understand that their application for liability insurance comprises far more than a basic questionnaire. For rescission purposes, an application can include an insurer�s own forms as well as any recent documents that have been filed with a regulator. For publicly held companies, this means that an error, omission or misrepresentation in filings with the SEC can lead to the rescission of a company�s D & O insurance.
When a liability policy insures only one person, the insured needs only to pay for coverage and remain honest with the carrier in order to avoid rescission. But when multiple insureds are involved, rescission can become a real concern for directors, officers and assorted professionals.
Suppose one executive is given the task of securing D & O insurance for several people and misrepresents facts on an application without telling anyone about it. Would that one person�s misrepresentations give the insurer the right to cancel everyone�s coverage?
It all might depend on whether the policy contains a �severability clause.� A severability clause requires an insurance company to separate an innocent insured from a guilty insured and lets innocent people maintain their coverage regardless of another person�s misrepresentations.
For a long time, D & O policies did not allow for severability, and even now, severability clauses can be narrow in scope. In addition to rescinding coverage from the people who sign an application, an insurance company may revoke coverage for anyone who knew or should have known about misrepresentations.
Considering all the liability risks that exist for professionals, a nervous observer may wonder why anyone would dare become a director, officer, doctor, lawyer or insurance agent. But that way of thinking is often impractical and unreasonable. After all, modern society would perhaps not function smoothly without the expertise and services of trained professionals. The public�s dependence on skilled doctors, lawyers, builders and the rest means that there may always be enough emotional and material awards attached to these professions to attract an assortment of willing and qualified candidates.
Apprehensive men and women who long for a professional career but shy away from one for fear of a legal dispute should realize that competence and care are not a person�s only shield in battles against liability. With the help of a knowledgeable insurance producer, they may be able to obtain a liability insurance policy that offers the necessary protection.