E&O INSURANCE seems to be resisting the general softening-market trend. Prices for E&O coverage have increased significantly. A bigger problem for agencies is reduced underwriting tolerance for claims; carriers are less forgiving than they have been. Agencies are trying harder than ever to prevent E&O claims, but many are failing to guard against two possible types because they are unaware the exposures exist: lawsuits brought against them by their carriers and the risks involved with E&S markets.

Carriers suing their own agencies

In the past, agencies and their companies were usually on the same team when clients filed E&O lawsuits. This was an advantage for agencies because the companies provided much-needed support. But anecdotal evidence suggests that company lawsuits against agencies are responsible for an increasing share of E&O suits. Agencies must now exercise the type of caution with their companies that they have always used with insureds. They must “document, document, document” discussions of coverage with companies and ensure all applications they submit are accurate and complete. Failure to do so is a big E&O exposure.

Clear communication between agencies and companies is more important than ever. One of the most common miscommunications involves binding coverage. Just because a company underwriter advises an agency the company will write a risk, for instance, does not mean the company has agreed to bind coverage.

Consider the following scenario: A company agrees to write a risk but has not yet bound coverage. The agency does not have binding authority but incorrectly advises the client that the company has bound coverage. The next day, the insured has a $300,000 claim. The company sees an opportunity to save a lot of money; it did not yet agree to bind the risk, so it doesn't have to pay the claim. The company might decide to reject the claim, or it may pay the claim and then sue the agency to recover the payment.

Though it might not sound fair, such a scenario is a real possibility-especially if a company has cash-flow problems, and the number of carriers with cash-flow problems could be significant. (For a more detailed discussion of this subject, see the Nov. 23, 2003, National Underwriter article, “Insurers, Reinsurers Not Living Up to Promises to Pay” and “The Loss of the Certainty Effect” by Stewart Economics, www.stewarteconomics.com.)

Agents can avoid problems by making sure everyone in the agency clearly knows what they can and cannot bind and understand the importance of explicitly requesting that a company bind and write a risk and not just write it. Everyone must understand the difference between a company agreeing to write a risk and a company agreeing to bind a risk. After all, a company can bind a risk for a short period of time, usually as a favor to the agency, with the clear understanding that they have no intention of ever writing it; the opposite practice is just as possible.

E&S markets

Several large E&O claims in the last few years have involved E&S brokers having less authority than they represented (or, according to some opinions, being outright crooks). Some claims involved agents who believed E&S brokers had binding authority with the E&S broker's company, when in fact they did not. As a result, the agencies' clients had no coverage-except under the agencies' E&O policies.

Independently verify that your brokers have binding authority with their companies – even if they assure you they do. Demand proof when they tell you their company has agreed to bind the risk. We cannot do this kind of business on a handshake. Agents should take the following precautions:

1) Always get E&O certificates of insurance from all of your E&S brokers. Their limits should equal or exceed the agency's E&O limits. This is not as important for large, nationally known brokers, but it is essential for all others, especially small brokers.
2) Read your E&S contracts carefully before signing them, and do not do business with an E&S broker until you have a contract agreeable to you.
3) Make sure your brokers represent the markets they claim to represent.
4) Never do business with brokers smaller than your agency.
5) Do business with as few E&S brokers as possible. This reduces E&O exposures considerably; using fewer markets, your staff does not have to learn or remember as much information. It will also help your agency develop better relationships with brokers, which often leads to better communication and further reduces E&O exposures. With fewer markets, your agency will be less tempted to write oddball stuff it has no business writing anyway.
6) Perform due diligence on your brokers every year, and don't make the common mistake of assuming that you are safe just because you have been doing business with small brokers or with the same brokers for an extended time. Such an assumption presumes that nothing ever changes. The two biggest E&O claims I have seen in the last six months involved agencies and E&S brokers with which they had done business for years.
7. Advise your customers of the risks associated with E&S markets before they purchase coverage. Too often, agencies advise clients only that a company is non-admitted-and this possibly only after the policy is written. Provide clients with complete disclosure of the risk involved, at the proposal stage as well as when the policy is issued. If you bring it up for the first time at policy issuance, it is too late for the client to shop for an admitted market.

E&O risks are increasing as agency-company and agency-E&S brokers relationships change, and the use of E&S markets increases. Is your agency prepared?

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