THE FINANCIAL condition of a carrier should be as important to you and your clients as a company's coverages, limits, premium and customer satisfaction ratings. If an insurer's ability to honor its commitments is doubtful, then its policy is not worth much. Furthermore, you can be sure that if a financially distressed carrier fails to meet its obligations to an insured, the insured will look to you. The consequences could be severe, because the typical insurance agents errors and omissions insurance policy contains an insolvency exclusion that bars coverage for claims arising from an insurer's financial failure. Therefore, you should do your best to ensure your carriers are in good financial condition. You also should notify your clients of your insurers' ratings, along with the other information you routinely provide them.
Checking the report card
Determining an insurer's financial strength is fairly easy. Best's (www.ambest.com), Moody's (www. moodys.com), Standard & Poor's (www.standardandpoors.com) and Fitch Ratings (www.fitchratings.com), among other organizations, provide ratings. Check at least two of these sources for ratings on the carriers you recommend to your insureds.
Best's also provides financial size ratings, using roman numerals. The larger the number, the bigger the carrier. For an ordinary policy-one with limits of $1 million to $5 million-financial size may not matter, but it could for an insured who desires higher limits. Also, some clients may have financial-size requirements (self-determined or imposed on them). For example, it is not unusual for a business to specify that its insurer must have, say, an A VIII rating at minimum.
Guaranty funds: an incomplete backup
State guaranty trust funds are intended to cover many claims that otherwise would go unpaid following a carrier's insolvency. Despite the name of these funds, they do not guarantee that every claim will be paid, or paid in full to clients. They should be regarded only as backup for you and your client-after you have done your job of checking on the financial strength of the proposed carriers and informing your client. If your client is insured by a nonadmitted carrier that becomes insolvent, however, a guaranty fund will afford no protection-which may motivate the insured to seek recovery from you. So when using nonadmitted insurers, you should have all the more incentive to provide the carriers' financial ratings to your clients, both to show your investigation and to document that insureds were informed. (For surplus-lines brokers, many states have statutes that impose on them a duty to investigate the financial soundness of the carriers they use or to use only surplus-lines carriers approved by the state's insurance commissioner.)
Advising clients
When your client has specified the coverages, limits, financial rating and size of the carrier he or she desires, obviously you must provide this information, along with principal exclusions and the quoted premium. Include this data even if an insured does not request it all. Many insureds are interested only in the premium quoted, which is initially understandable, all things being equal-but a financially weaker company is not equal. If you recommend a company that is rated higher than the one the client desires, make this clear and document it. Sometimes, of course, the only choice open to the client is a lower-rated company. In such cases, the client should understand that you were unable to obtain quotes from stronger carriers.
Case law in many states imposes a duty on agents to not place coverage with carriers they know (or should have known) to be financially unsound. Some states' courts have not specifically addressed the point, but the only ruling to the contrary has come in California, where a 1979 decision, Wilson vs. All Services Ins. Corp., 91 Cal.App.3d 793, 153 Cal.Rptr. 121 (1979), held that if a broker uses a carrier approved by the insurance commissioner, then the broker meets his duty and no further inquiry about the insurer is required.
Agents do not necessarily fulfill their duty just by providing information about a carrier's financial condition at the time coverage is put in force. A carrier's financial condition subsequently can deteriorate, leading to a ratings downgrade. While an agent is not a guarantor of a carrier's solvency, a few cases have required agents to inform clients of a carrier's financial misfortune whenever an agent learns (or should have learned) about it. [See, for example, the Texas case, Cateora vs. British Atlantic Assur. Ltd. of Nassau, Bahamas 282 F.Supp. 167 (S.D. Tex. 1968).] There may be a cost to switching clients midstream, but the cost of an unpaid claim could be a lot higher.
Insolvency's effect on E&O coverage
Agents have good reason-apart from ensuring good relations with clients-to stay on top of their insurers' financial condition. Most agents' E&O policies contain an exclusion that bars coverage for claims arising out of a carrier's failure to pay a claim because of insolvency, receivership or other financial difficulty. (The wording of these exclusions varies, so agents should check their policies carefully. Some E&O carriers, for example, preserve coverage if an agent's carrier had a minimum specified rating and size.) Insolvency exclusions have been litigated in a number of cases around the country. For the most part, they have been upheld. The principal cases are from New York [Kleneic vs. White Lake Marine Corp., 144 A.D.2d 341, 533 N.Y.S.2d 909, 910 (1988)], Louisiana [Barron vs. Scaife, 535 So.2d 830, 832 (La. 1988)] and Georgia [St. Paul Fire and Marine Ins. Co. vs. Cohen-Walker, Inc., 171 Ga.App. 542, 320 S.E.2d 385 (1984)].
A few cases have negated insolvency exclusions, although the facts in each of these cases limited the ruling's applicability. Thus the decisions did not really lessen the strength of the exclusion. For instance, in an Alabama case, St. Paul Fire & Marine Ins. Co. vs. Molton, Allen & Williams Corp., 592 So.2d 199 (Ala. 1991), the claim against the agent was for a refund of the premiums paid, not for an unpaid claim. A California case, Conestoga Services Corp. vs. Executive Risk Indemnity Co., found that the agent's malpractice in failing to forward a rider was a separate cause of the loss, which kept the insolvency exclusion in the agent's E&O policy from barring coverage.
Documentation: the best defense
As always, the best defense is documentation that you investigated the financial soundness of an insurance company and forwarded your findings to the client, along with all other material facts concerning the insurance requested. If you provide advice (e.g., to use a highly rated insurer rather than a lower-rated carrier offering a more attractive premium), you also want to be able to document it, as well as whether the client chooses to follow it. As always, confirm everything in writing. Even if your own E&O policy does not provide a defense because of an insolvency exclusion, you will want to have the information necessary to mount a strong and economical defense for yourself.
Attorney Harold Weston is an insurance and risk management consultant with Creative Risk Consultants International. Prior to joining the firm, he was in-house counsel at Fireman's Fund Insurance Co. Mr. Weston can be reached at hweston@crcinternational.net.
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