By Steve Germundson, AAI and Douglas Ruml,CFM

Let's start by telling an agency E&O story: misplaced thriftturned into a tale of woe. We received a request from an agency fora quote on its E&O coverage. As we looked over the submission,we noticed a long list of different carriers the agency had beenwith over the past few years. Because the list was arrangedchronologically, we could see that although the agency securedprogressively lower premium by moving their account every year ortwo, it also ended up with progressively less coverage as theagency settled for policy forms offered by the low-cost carriers.They came to us after submitting a huge claim to their currentcarrier, who immediately advised them that they would not berenewed. The low cost carrier also dragged out payments, leading tosome cash-flow issues.

Now the agency was scrambling and spending a great deal ofunproductive time dealing with these problems. The impact on itsbottom line was considerably more than what they'd saved over thepast decade on cheaper policies. They also ended up damaging theirown brand with a large client unhappy at not being servicedproperly.

Related: Read “Tipsfor shopping your E&O coverage.”

The moral of the story: Sometimes you get what you pay for.

Part of agency risk management is the agency's purchase of itsown professional liability insurance, but there is much moreinvolved. Agency risk management also should include putting inplace the policies, procedures and culture that will allow areduction of risks, and thus save the organization real,bottom-line dollars. Here are some of the ways that agency riskmanagement can actually save an agency money.

Causes of loss

First, let's consider the main causes of agency E&O claims.What does it take for an “error” or “omission” to become an E&Oclaim? When an insured or an insurance company suffers a financialloss based on the perception that an agent's actions or inactionswere not up to the perceived standard of care, a claim is born.Virtually every claim boils down to, “What was expected by yourclient?”

Take a look at an agency's marketing material or website. Is theagency really prepared to meet its own “standard of care”? Can anysuch organization meet the high standards claimed in its ownmarketing material?

Related: Read AA&B survey: “Periloustimes make E&O a must.”

Look at it another way. Considerhow many insurance companies the agency represents, the number ofclients, the thousands of policies written by a large number ofemployees and the tens of thousands of transactions taking place inany given month or year. It is surprising that there aren't moreE&O claims! The basis of what agents do daily is getting peopleto agree with each other about the exchange of money, somethingthat is fraught with opportunities for misunderstanding and bitterrecriminations.

The set of elements in place for an E&O claim to arise isfinancial harm and a breakdown in standard of care. What an agencysays about its standard of care can be used by the plaintiff'slawyer to paint the agent as apathetically neglecting her duty as aprofessional.

When we look at the actual causes of loss, the top cause, basedon our experience, is the failure to provide proper coverage (morethan 50 percent of the claims with which we're familiar come fromthis). What can go wrong? Some examples include purchasinginadequate limits of liability, a gap between primary and excesspolicies, a lapsed policy or failure to attach an endorsement andmany more.

Rounding out the top three causes of agency E&O claims inthe several programs for which we have seen current data are claimmishandling (more than 15 percent of all claims) andmisrepresentation (more than 10 percent of claims). We should alsopoint out that because claims come from every line of business, noagent can truly say, “It could never happen to me.” Commercialinsurance continues to generate the most claims activity due to itsinherent difficulties and lack of standardization, but personallines, life, accident and health have all seen their percentage ofclaims go up during the last 5 years.

Claims prevention methods

We know where claims come from, so how do we keep them fromhappening? The two most important things are having the rightpeople and having the proper agency infrastructure (i.e., thethings that support the people: systems, procedures andenvironment).

When we review claims and incidents, we always work back todetermine what could have been done to prevent that particularclaim. Some of the methods could include formal policy reviews,consistent file documentation and obligatory exposure analysis.

Claims prevention isn't limited to procedures. Attitudes andphilosophies are critical as well. Few attitudes are more importantthan agents being selective with whom they do business and avoiding“bad” clients and “bad” wholesalers. What would constitute a “bad”client? Indicators would include slow pay/no pay customers as wellas clients who have a hard-to-understand business (or are slipperyin explaining what they are actually doing). Although there is noway to measure this subjective issue, we believe that about half ofclaims come from these types of “bad” accounts. “Bad” brokers, onthe other hand, are those you are paying to provide your clients aservice, but who are notoriously slow to respond, can rarely seemto provide an actual policy accurately or timely, and so forth. Alot of E&O claims arise from brokered business.

Quality management

Effective E&O risk management programs can lead totransformative quality management initiatives in agencies. That'sbecause flowing from claims prevention methods are a number offactors that fit in with improving customer satisfaction andsupporting the growth of the agency. These would be the kinds ofprocedures that make for both less E&O exposure and happierclients.

Organizational structures, both macro (such as lines ofreporting and risk managers having authority to be able toterminate employees) and micro (such as work flows and jobdescriptions) are parts of E&O claims prevention, but also ofother types of risk management (example: human resources-basedrisks such as employment practices). In addition, these types ofstructures go a long way to institutionalizing what needs to bedone to ensure you're providing client-focused services. Theybecome a part of the managerial infrastructure in an agency thathelps to support organic growth and provide an organizationalskeleton for the addition of acquired or merged agencies.

Internal or external auditors/reviewers in agency riskmanagement programs also make direct recommendations, which theythen discuss and later follow up on. This adds a level ofaccountability which fosters the execution of needed qualityimprovements and the avoidance of serious problems or overlooked“holes” in procedures which could result in claims and damagedbrand value.

An internal file review practice is the touchstone of qualitymanagement we have with the E&O Plus program: Agencies arehelped to form the risk management procedures that fit the type ofoperations they are involved in. These reviews are the way youcheck on how you're doing–both in individual files and,collectively, on procedures. Hand-in-hand with this is the annual(at a minimum) visit of an external reviewer. This externalreviewer can give an outside perspective, and can benchmark anagency's progress and results quantitatively against a peergroup.

Being involved with agent organizations related to risk andquality management allows firms to reduce errors and improvesuperiority to their competition via networking with otherexcellent agencies. Besides the peer pressure that can be exerteddue to accountability conventions, it is also an excellent way tolearn what others are doing right and finding out mistakes toavoid. In our program, the partner agencies input internal auditresults for full-program benchmarking.

Business growth

As firms grow and evolve, they need human, strategic andorganizational changes to continue to succeed. Agencies are nodifferent. First, since the quality management is intimately linkedto the staff of an agency, such as through training or developing aclient-centered corporate culture, it becomes part of thesystemization of productive staff behaviors. Second, a properlycrafted risk management initiative should be a part of everyagency's long-term growth strategy. Growing, profitable clientsneed the support of high-quality agencies. Finally, qualitymanagement is all about organizational and procedural initiativessuch as zero-error service goals and workflow optimization. Qualitymanagement helps to make profitability through the use of itseffect on the people, strategies and systems within an agency.

Overall, quality saves. Investments in quality products andservices over the long term have been shown to actually reducecosts and make companies with quality-based cultures more appealingbusiness partners. TQM, Six Sigma, ISO, W. Edwards Deming,Continuous Improvement Process (CIP), Japanese productionmanagement, Kaizen–all are driven by the insight that qualitysaves.

This also applies to the broadness of the policy form being usedfor an agency's own E&O. Broader coverage simply captures morelosses. If executive management has found a carrier that “canmanuscript anything” into the policy, and can craft it to cover anagency's unique operations and exposures, they will be saving moneyin the long run. When incidents and claims occur, they aresheltered from the cost because the exposure is covered, where in aless expensive, but lower quality policy, there would be nocoverage. And this has a statistically significant effect on thebottom lines of agencies that are underwritten in programs withsuch broad policy coverage.

Clients

Quality involves a mindset of treating clients better. And ahappy client is generally one more loyal to the provider of theservice–and much more likely to recommend an agency to others. Thispositive client experience is a result of the operational andprocedural changes made during the ongoing risk management-qualitymanagement process. Remember: If an agency is not looking out forits clients, it is a pretty good bet that the clients' lawyers arelooking out for their best interest.

One of us (Doug) spent 3 years as a professor at the FranklinUniversity Graduate School of Business while under non-competeafter selling his ownership in an agency that specialized inprofessional liability. Besides teaching, he was able to do someresearch. One of these studies involved the effect of agency riskmanagement on the bottom line of agencies. This study found thatthe total cost of risk decreased almost 50 percent in the 3 yearsafter implementing a quality management program. It was probablyeven more positive to the bottom- line if client satisfaction andorganizational efficiency, which could not be captured in thestudy, were considered.

What was most interesting was that this data came from a programthat he had unsuccessfully competed against in the past–a programthe other author (Steve) was involved in. Doug could sell agenciescheaper policies, but he couldn't sell them better qualitymanagement. In the long run, the agencies with better qualitymanagement ended up better off than they would have with lessexpensive policies, all as the result of what is outlined here.