As E&O risks grow, a key defense remains unchanged

ON THE SURFACE, there is a simple explanation for all insurance agents' errors and omissions claims: The claimant wants insurance to cover a loss and blames the agent because it doesn't. The underlying causes, however, are more complex.

Insurance agents today are facing greater scrutiny. Two recent court cases are likely to have a major impact on agent E&O claims. They involve different coverages and different agent duties, but they point to a single conclusion: That the responsibility of insurance agents may be expanding.

This spring, the California Supreme Court refused to review an unusual case that now stands as a potential precedent for other E&O claims. A U.S. business contacted a retail broker to procure E&O insurance for a software company based in India. The software company needed the insurance to satisfy a condition in its contract with the business. A retail agent placed the policy through a wholesale broker.

The software company failed to deliver useable software. The U.S. business sued and was awarded nearly $1 million-but the judgment was uncollectible for lack of insurance coverage. That's because the E&O policy procured for the software company excluded coverage for claims arising from work performed in India.

The U.S. business sued the wholesale broker for negligence in procuring a policy that did not provide the needed protection. The trial court dismissed the case on the grounds that the wholesale broker did not owe a duty of care to the business, since it was not the broker's client.

The California Court of Appeals reversed the decision. It ruled that the business was “not quite (but) close enough” to being the intended beneficiary of the broker's services to impose a duty on the broker.

Despite this case's atypical nature, it has the potential to expand the traditional obligations of all insurance professionals. While the court expressly limited its decision to the facts of the case, it is possible to project this ruling to situations in which retail insurance agents place coverage that is mandated by contracts their insureds enter into with other parties. Only time will tell whether this precedent will be used against insurance agents, but it underscores the need for agents to be diligent in documenting coverage discussions with insureds.

In the second case, which was decided last month, a Mississippi homeowner sued his agent to collect for uninsured flood damage arising from Hurricane Katrina. The homeowner, who did not live in a high-hazard flood area, said the agent told him he didn't need flood insurance. The homeowner construed that to mean that such coverage was provided by the homeowners policy. A federal district court rejected the homeowner's claim, while adding that his erroneous inference “might have been avoided had either party to the conversation been more articulate in his inquiry or his response.”

Agents should not take too much comfort from the decision, however, since similar lawsuits are pending against other agents and insurance companies. If any are decided in favor of the plaintiffs, thousands, if not tens of thousands, may follow. Agents will be required to prove that they fully understood the limitations of the policies they sold and that they properly advised their clients of those limitations.

One element repeats itself in these claims: The client's belief that the agent did not procure coverage that was specifically requested. This also is the most frequently cited cause of claims made against the agents we insure for E&O. A recent review of the larger claims made against our clients over the last 15 years showed that about half of them fell into this category. In more than 20% of the claims, the agency agreed that it made such an error.

We found a variety of causes for the problems. Several claims resulted from a change in insurer; the new insurer's policy did not match the expiring coverage. In a few cases, the agency neglected to submit premiums or information to the insurer. Other claims resulted from an agent's failure to obtain full information from a client; e.g., a complete list of all named insureds.

The overriding issue in most claims is that the insured and the agent disagree about what coverage was to be procured. Fortunately, some agencies have excellent documentation and so can easily extract themselves from such claims. Most agencies, however, are not so well prepared.

One important loss-control procedure is illustrated by both of the previously cited cases: Review coverage limitations and exclusions with your client-and document that review. If the only software E&O policy you can find includes an exclusion for work done in India, you must specifically disclose that fact to the client. If you are reviewing the hurricane-coverage provision of a homeowners policy with a client, you need to discuss its limitations for flood damage.

Another important step is to use an exposure-analysis checklist-for both personal and commercial accounts. Most, if not all, agency management systems include them in their software. When using such checklists, however, be sure to obtain the client's signature acknowledging those coverages that he or she declined.

While diligent documentation may seem to require a lot of work, it pales in comparison to the totally counterproductive time you will spend in dealing with an E&O claim. An E&O claim can be emotionally draining as well. Complete documentation is one of the best defenses against it. Documentation also helps prevent claims in the first place. When your client signs off on a checklist or receives a memo highlighting a policy limitation, that limitation is much less likely to lead to an E&O claim.

Another common risk highlighted in the aforementioned court cases is lack of product knowledge. The software E&O case, in particular, focused primarily on the appropriateness of the policy.

Lapses in product knowledge normally arise from one of three causes: placing a policy outside the norm of those typically handled by an agency, placing a policy for an insured in another state, and placing a policy for an industry in which the agent has limited or no experience. In such situations, agents may make assumptions that proved costly. Here are examples:

oA business has an E&O policy through a specialty agent. The agent who handles all of the standard policies for the business obtains a lower-cost proposal when the E&O policy renews. The client accepts the propo-sal. An E&O claim ensues. The lower-priced policy doesn't respond because it lacks prior-acts coverage for predecessor firms-a coverage the policy sold by the specialty agent contained. The missing coverage created a huge gap which was filled, unfortunately, by the standard-lines agent's E&O policy.

oAn agent places a workers compensation policy for a client in a bordering state. The policy is written as excess of the state's workers compensation fund. The state fund changes procedures, requiring each insured to apply specifically for primary coverage with the state fund. The agent is not aware of the change and renews the existing policy for several years without incident. When a workers compensation loss occurs, the client discovers that it is uninsured for the first $500,000 of any claim.

oAn agency routinely places group life and health benefits. It obtains a large religious organization as a new client. A missionary serving overseas dies of a heart attack. The organization's policy does not provide coverage for foreign-based employees. The agency had never worked with a client that had people in foreign locations and failed to ask where all the organization's workers were located.

Continuing education can help prevent claims that arise from a lack of product knowledge, provided it is directly related to the coverages an agency places. Agents should proceed cautiously when working in unfamiliar territory. It is better to forgo the commission on a single policy than to lose an entire client to an E&O claim. A good client will respect a referral to a more-qualified provider for a specialty policy. Such a referral provides an opportunity to highlight the agent's role as a trusted adviser, rather than as just a salesperson taking orders.

Poor client selection is one of the more frustrating root causes of E&O claims. All too often the receipt of an E&O claim is followed by the agent's comment, “I should have known.” Clients who are difficult, demanding and unreasonable are not likely to work with their agents to mitigate loss exposures. Clients who try to hide information to obtain lower premiums are especially risky. Problem clients cost agencies more in time and attention than is warranted by the commissions generated. It is far better to politely tell a troublesome client that you are unable to place their coverage (and document your decision in writing!) than to rue your lack of action after a claim is presented.

The agents E&O environment is changing, and agents' duties may yet be expanded by the aforementioned California case and by what is still being decided in cases along the Gulf Coast. Existing exposures continue to haunt agencies as well. In this changing environment, a few simple loss-control techniques can make a big difference: Use coverage checklists, review exclusions and coverage limitations, stay within your expertise, choose your clients carefully and, above all, document, document, document.

Jim Romano and Michelle Duffett are co-founders of Insight Insurance Services, which they started in 1987. Insight Insurance Services is a program administrator specializing in professional liability for architects, engineers, accounting professionals and insurance agents. Mr. Romano holds a bachelor's degree from Carroll College and is a member of the Professional Liability Underwriting Society. Ms. Duffett holds a bachelor's degree from the University of Michigan and a master's degree in management from Northwestern University.