Agents for insurance companies may not besecret ones, but insurance and secret agents both take names andissue numbers. Policy numbers.

Agents in the insurance world have a "licence to bill"(premiums), issued not byBritain's Secret Intelligence Service, butby the state department of insurance; and not in the service of HerMajesty, but at the appointment of one or more insurers.

The insurance agent provides products to people and businessesthat can reduce the financial impacts of everyday dangers. Theagent acts as conduit for those dangers, spreading them among amuch larger population, but in doing so takes on a litigationrisk—regardless of the merits—that may materialize when thecoverage is not broad enough in scope or high enough in limits toadequately protect the policyholder ("adequacy" being viewed withthe benefit of 20/20 hindsight).

Duties of Care

It is the agent's role to transact business with the public onbehalf of the carrier, but that role is sometimes misunderstood bypolicyholders and even by some agents. That insurance brokers alsoare "agents" of the policyholder in procuring insurance coverage,in the principal/agent sense of the word, adds to the confusion.("Loss Control and Selling Don't Always Mix,"March 2011 AA&B.)

Miscommunications among policyholders, appointed agents andinsurers are at the root of most errors and omissions (E&O)claims against insurance agents. That's why defense attorneys forinsurance professionals always counsel their clients to confirmcommunications in writing. Even though E&O claims usually arisefrom communication problems, when such claims are expressed inlegalese they are phrased as breaches of duties of care owed to thepolicyholder or, more rarely, duties owed to the insurer for whomthe agent is transacting coverage.

Related: Read "The 'M' Word"

Agents must understand the extent of their legal duties so theycan fulfill their roles as conduits of others' risks withoutbecoming repositories of those risks. In general, an insuranceagent's duties stem from four sources:

• The written agency contract with the insurer(s) whom the agentrepresents
• The state's laws and regulations that govern the conduct of theinsurance business
• Commitments made by the agent to the public
• "Special relationships" with particular customers that mayarise over years of service or from other limitedcircumstances.

Contract

The written agency contract is the least subjective of all thesources of duties because it is specific to the agent and insurerin question. The agent's authority—the extent to which he or shehas "the pen" for the carrier—is typically spelled out in detail,as are the investigatory steps, if any, that the agent must takebefore binding a risk that is within that authority. Still, beingonly human, people make mistakes.

Sometimes human error leads to an uncleardescription of the risk (see sidebar, "Human Error's Effect onContracts"). In other instances, the agency contract is breached ina way that doesn't appear on the application for insurance.Example: aMassachusettscase involving an exclusivity clause in anagency's contract. In return for receiving a limited "power of thepen" as an insurer's managing general agent, the agency gave theinsurer what might be called a "right of first refusal" on businessfalling within the scope of is authority.

The insurer initiated arbitration against the agency fordiverting $12 million in business to another carrier without firstgiving the insurer a chance to underwrite those risks—andprevailed. The agency then filed suit against its E&O liabilityinsurer, which had denied coverage, arguing that the breach ofcontract was a conscious business decision, not an error inprofessional services. The U.S. District Court agreed, deeming thediversion of business not to be an exercise of professionalexpertise, and the First Circuit Court of Appeals affirmed, findingthat the diversion was a "distinct business decision … like leasinga building, buying supplies or charging for services."(Massamont Ins. Agency v. Utica Mutual Ins.Co., 487 F.3d 71, 74 (1st Cir. 2007, citing cases fromNewYork,Minnesota andSouth Dakota.)

A more typical cause of friction between insurers and theiragents arises when the most effective E&O preventative toolever invented, the telephone, is underused. I have heard fromunderwriters that no matter how busy they are they would ratherreceive phone calls from agents than let an issue develop thatmight lead to a lawsuit.

Related: Read "Fun With FINRA"

Laws

Laws that govern insurance agents and other carrierrepresentatives can impose duties to the public. Perhaps the mostbasic example is the definition of an "insurance agent" in statutessuch as California Insurance Code section 31: "Insurance agentmeans a person authorized, by and on behalf of an insurer, totransact all classes of insurance other than life, disability, orhealth insurance, on behalf of an admitted insurance company."Those three little words "on behalf of" speak volumes: The agent'sduties are owed to the insurer, absent an exception.

And there are exceptions. Section 1733 in the same Code providesthat "All funds received by any person acting as a licensee underthis chapter … as premium or return premium on or under any policyof insurance or undertaking of bail, are received and held by thatperson in his or her fiduciary capacity." The fiduciary duty on theagent's or broker's part (both being "licensees") isn't clearlystated to be owed only to the insurer, though the duty has beeninterpreted for decades by courts as flowing to both the insurerand the policyholder.

State legislatures impose many other duties—for example, noticerequirements for cancellations and non-renewals and privacy lawsprotecting consumers' financial and health information fromunauthorized disclosure. Because the statutes and insuranceregulations are state-specific and subject to amendments, a robustprogram of continuing education is the best protection whenwandering through the legal minefield.

Commitments

When one promises another to perform (or not perform) somethingvery specific for the benefit of someone else, and the secondperson reasonably relies on the promise and is materially damagedby having so relied, the first person may be liable for theforeseeable damages that are incurred. The loss can't be remote orspeculative; enforcing the promise must be the only way to cure theinjustice. It's called "promissory estoppel."

A Missouricase illustrates the point. In Clevenger v. Oliver Ins. Agency, 237 S.W.2d 588(Mo., 2007), the state's Supreme Court drew a distinction betweenclaims based on promises and claims based on negligence. Aninsurance agent had "promised" that a pollution liability policy heprocured for a ranch would cover a potential claim by an adjoininglandowner for contamination of the neighbor's lake. The pollutionclaim was later made, but the insurer denied coverage, relying on apolicy endorsement. A jury found the agent liable under negligenceand promissory estoppel theories, holding the agent responsible for$1,095.13 on the negligence count (the cleanup costs of $78,223.82,less the 98.6 percent comparative negligence that the jury assessedagainst the policyholder), but for the full $78,223.82 in damagesunder the promissory estoppel theory, to which comparativenegligence did not apply under Missouri law.

The state's high court reversed the promissory estoppel portionof the judgment because the negligence claim, including the jury'sassessment of comparative negligence, was a remedy. The differencebetween the promissory estoppel and negligence remedies had adramatic effect on the damage award because the jury found such ahigh degree of fault on the policyholder's part. Still, the court'sdecision does not say what the agent's attorney's fees totaledafter a jury trial, a post-trial motion, an appeal to theintermediateMissouricourt and a final decision by the MissouriSupreme Court.

Special Relationships

Duties also can arise through a course of conduct over a longperiod of time. This is the most amorphous source of duties of carethat insurance agents face, because it is only found to exist withbenefit of hindsight by 12 good citizens, sworn and true, in a juryroom.

In an April 17, 2013 decision, New York's Second AppellateDivision found that there was a "triable issue of fact" as towhether an agent had a special relationship with a medicalassociation for which he had placed commercial insurance for 4years. In the fifth year of coverage, the carrier renewed with alengthy explanation of policy changes, including a reduction incoverage for employee dishonesty from $250,000 to $25,000. Theassociation received the notice but failed to read it, and sued thecarrier and the agent, having incurred an employee dishonesty lossthat was higher than the new $25,000 limit. (South Bay Cardiovascular Assoc. v. SCSAgency, 105 A.D.3d 939 (N.Y.App. Div. 2d Dept 2013).)

The trial court granted summary judgment to the carrier butrefused to dismiss the agent from the case. The Appellate Divisionagreed, explaining that there was evidence of a specialrelationship betweenSouthBayand the SCS defendants, and noting thatthere was testimony that theSouthBayemployee did not read thepolicies.

Related: Read "Certain Uncertainty"

One may question whether a 4-year business relationship is "anextended period of time" and whether employees whose jobs requirethat they procure insurance with the aid of outside professionalsshould be rewarded for failing to read notices of changed policyterms.

If the fact patterns and results discussed in this article leavethe reader a bit "shaken," let the reader also be "stirred" toaction by revisiting his or her agency's risk management proceduresin light of its contractual obligations, applicable law andpolicies regarding communications with the public.