By Steve Germundson, AAI and Douglas Ruml, CFM
Let's start by telling an agency E&O story: misplaced thrift turned into a tale of woe. We received a request from an agency for a quote on its E&O coverage. As we looked over the submission, we noticed a long list of different carriers the agency had been with over the past few years. Because the list was arranged chronologically, we could see that although the agency secured progressively lower premium by moving their account every year or two, it also ended up with progressively less coverage as the agency settled for policy forms offered by the low-cost carriers. They came to us after submitting a huge claim to their current carrier, who immediately advised them that they would not be renewed. The low cost carrier also dragged out payments, leading to some cash-flow issues.
Now the agency was scrambling and spending a great deal of unproductive time dealing with these problems. The impact on its bottom line was considerably more than what they'd saved over the past decade on cheaper policies. They also ended up damaging their own brand with a large client unhappy at not being serviced properly.
Related: Read "Tips for 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 its own professional liability insurance, but there is much more involved. Agency risk management also should include putting in place the policies, procedures and culture that will allow a reduction of risks, and thus save the organization real, bottom-line dollars. Here are some of the ways that agency risk management 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&O claim? When an insured or an insurance company suffers a financial loss based on the perception that an agent's actions or inactions were not up to the perceived standard of care, a claim is born. Virtually every claim boils down to, "What was expected by your client?"
Take a look at an agency's marketing material or website. Is the agency really prepared to meet its own "standard of care"? Can any such organization meet the high standards claimed in its own marketing material?
Related: Read AA&B survey: "Perilous times make E&O a must."
Look at it another way. Consider how many insurance companies the agency represents, the number of clients, the thousands of policies written by a large number of employees and the tens of thousands of transactions taking place in any given month or year. It is surprising that there aren't more E&O claims! The basis of what agents do daily is getting people to agree with each other about the exchange of money, something that is fraught with opportunities for misunderstanding and bitter recriminations.
The set of elements in place for an E&O claim to arise is financial harm and a breakdown in standard of care. What an agency says about its standard of care can be used by the plaintiff's lawyer to paint the agent as apathetically neglecting her duty as a professional.
When we look at the actual causes of loss, the top cause, based on our experience, is the failure to provide proper coverage (more than 50 percent of the claims with which we're familiar come from this). What can go wrong? Some examples include purchasing inadequate limits of liability, a gap between primary and excess policies, a lapsed policy or failure to attach an endorsement and many more.
Rounding out the top three causes of agency E&O claims in the several programs for which we have seen current data are claim mishandling (more than 15 percent of all claims) and misrepresentation (more than 10 percent of claims). We should also point out that because claims come from every line of business, no agent can truly say, "It could never happen to me." Commercial insurance continues to generate the most claims activity due to its inherent difficulties and lack of standardization, but personal lines, life, accident and health have all seen their percentage of claims go up during the last 5 years.
Claims prevention methods
We know where claims come from, so how do we keep them from happening? The two most important things are having the right people and having the proper agency infrastructure (i.e., the things that support the people: systems, procedures and environment).
When we review claims and incidents, we always work back to determine what could have been done to prevent that particular claim. Some of the methods could include formal policy reviews, consistent file documentation and obligatory exposure analysis.
Claims prevention isn't limited to procedures. Attitudes and philosophies are critical as well. Few attitudes are more important than 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 well as clients who have a hard-to-understand business (or are slippery in explaining what they are actually doing). Although there is no way to measure this subjective issue, we believe that about half of claims come from these types of "bad" accounts. "Bad" brokers, on the other hand, are those you are paying to provide your clients a service, but who are notoriously slow to respond, can rarely seem to provide an actual policy accurately or timely, and so forth. A lot of E&O claims arise from brokered business.
Effective E&O risk management programs can lead to transformative quality management initiatives in agencies. That's because flowing from claims prevention methods are a number of factors that fit in with improving customer satisfaction and supporting the growth of the agency. These would be the kinds of procedures that make for both less E&O exposure and happier clients.
Organizational structures, both macro (such as lines of reporting and risk managers having authority to be able to terminate employees) and micro (such as work flows and job descriptions) are parts of E&O claims prevention, but also of other types of risk management (example: human resources-based risks such as employment practices). In addition, these types of structures go a long way to institutionalizing what needs to be done to ensure you're providing client-focused services. They become a part of the managerial infrastructure in an agency that helps to support organic growth and provide an organizational skeleton for the addition of acquired or merged agencies.
Internal or external auditors/reviewers in agency risk management programs also make direct recommendations, which they then discuss and later follow up on. This adds a level of accountability which fosters the execution of needed quality improvements and the avoidance of serious problems or overlooked "holes" in procedures which could result in claims and damaged brand value.
An internal file review practice is the touchstone of quality management we have with the E&O Plus program: Agencies are helped to form the risk management procedures that fit the type of operations they are involved in. These reviews are the way you check 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 external reviewer can give an outside perspective, and can benchmark an agency's progress and results quantitatively against a peer group.
Being involved with agent organizations related to risk and quality management allows firms to reduce errors and improve superiority to their competition via networking with other excellent agencies. Besides the peer pressure that can be exerted due to accountability conventions, it is also an excellent way to learn what others are doing right and finding out mistakes to avoid. In our program, the partner agencies input internal audit results for full-program benchmarking.
As firms grow and evolve, they need human, strategic and organizational changes to continue to succeed. Agencies are no different. First, since the quality management is intimately linked to the staff of an agency, such as through training or developing a client-centered corporate culture, it becomes part of the systemization of productive staff behaviors. Second, a properly crafted risk management initiative should be a part of every agency's long-term growth strategy. Growing, profitable clients need the support of high-quality agencies. Finally, quality management is all about organizational and procedural initiatives such as zero-error service goals and workflow optimization. Quality management helps to make profitability through the use of its effect on the people, strategies and systems within an agency.
Overall, quality saves. Investments in quality products and services over the long term have been shown to actually reduce costs and make companies with quality-based cultures more appealing business partners. TQM, Six Sigma, ISO, W. Edwards Deming, Continuous Improvement Process (CIP), Japanese production management, Kaizen--all are driven by the insight that quality saves.
This also applies to the broadness of the policy form being used for an agency's own E&O. Broader coverage simply captures more losses. If executive management has found a carrier that "can manuscript anything" into the policy, and can craft it to cover an agency's unique operations and exposures, they will be saving money in the long run. When incidents and claims occur, they are sheltered from the cost because the exposure is covered, where in a less expensive, but lower quality policy, there would be no coverage. And this has a statistically significant effect on the bottom lines of agencies that are underwritten in programs with such broad policy coverage.
Quality involves a mindset of treating clients better. And a happy client is generally one more loyal to the provider of the service--and much more likely to recommend an agency to others. This positive client experience is a result of the operational and procedural changes made during the ongoing risk management-quality management process. Remember: If an agency is not looking out for its clients, it is a pretty good bet that the clients' lawyers are looking out for their best interest.
One of us (Doug) spent 3 years as a professor at the Franklin University Graduate School of Business while under non-compete after selling his ownership in an agency that specialized in professional liability. Besides teaching, he was able to do some research. One of these studies involved the effect of agency risk management on the bottom line of agencies. This study found that the total cost of risk decreased almost 50 percent in the 3 years after implementing a quality management program. It was probably even more positive to the bottom- line if client satisfaction and organizational efficiency, which could not be captured in the study, were considered.
What was most interesting was that this data came from a program that he had unsuccessfully competed against in the past--a program the other author (Steve) was involved in. Doug could sell agencies cheaper policies, but he couldn't sell them better quality management. In the long run, the agencies with better quality management ended up better off than they would have with less expensive policies, all as the result of what is outlined here.