Writer’s Cramp

A profit center for surplus line brokers is a facility where they take the insurer's pen and act as underwriters of all risks accepted through their facility on behalf of the insurer. Some of these agreements have little detail other than an agreement to write insurance. Then there are others, like the agreement that was the subject of litigation in GeoVera Specialty Insurance Co., Formerly Known As Usf&G Specialty Insurance Co. v. Graham Rogers Inc., No. 10-1943 (8th Cir. 04/13/2011).

GeoVera Specialty Insurance Co. (GeoVera) entered into such an agreement with Graham Rogers Inc. (Graham), a surplus line broker. GeoVera claimed that Graham breached the contract by allowing one of its retail brokers to submit a risk in Arkansas that did not fulfill the mandatory underwriting guidelines that were the basis of the contract between GeoVera and Graham.

GeoVera appealed a district court's grant of summary judgment to Graham on GeoVera's claims for breach of contract and negligence. The agreement required that Graham underwriter policies complied with the insurer's underwriting guidelines. GeoVera, an insurance company, and Graham, a wholesale insurance broker, entered into a surplus lines broker agreement effective June 1, 2003. "Subject to the underwriting rules and regulations" of GeoVera, the agreement authorized Graham "to market, present proposals of residential property insurance to [GeoVera] for its acceptance, and issue and deliver residential property insurance policies." By entering into the agreement, GeoVera sought to tap into Graham's network of retail insurance agents as long as the risks written complied with the guidelines.

Related: Watch a video, "If the sheet fits: Zalma on Fox Business News".

GeoVera also maintained an electronic residential homeowner quoting and homeowner insurance processing system. The agreement contemplated that the retailers appointed by Graham could submit applications to GeoVera by means of the system. Article III of the agreement provided that "[GeoVera] will give [Graham], and retail producers appointed by [Graham] under this Agreement, access to the System for purposes of sending quote requests, receiving quotes, and printing and delivering quotes, applications, and binders." The agreement also provided that, after "[Graham] and/or retail producers" complete an insurance application, "[t]he System will then provide a quote response to [Graham] and retail producer" The system also would send "daily pre-formatted reports" to Graham.

On Sept. 24, 2003, Graham entered into a retail producer agreement with insurance agent Jerry Reeves of East Central Arkansas Insurance (ECA). In 2004, Reeves submitted a homeowner's insurance policy application for the home of Gary and Sherry Balentine. GeoVera accepted this application and issued the policy. In 2006, GeoVera cancelled the Balentines' policy because they failed to make a premium payment. Subsequently, the Balentines reapplied for insurance through Reeves, and GeoVera issued a new policy.

Soon after, the Balentines filed a claim with GeoVera for residential fire damage. During GeoVera's investigation of the claim, it discovered that the Balentines would not have qualified for coverage under GeoVera's underwriting guidelines because:

1. The insured residence was on 6 acres of land, while the application stated that it was on 5 acres or fewer. Insured lots may not exceed 5 acres under the GeoVera underwriting guidelines.
2. The Balentines had filed for bankruptcy in 2005, while the application stated that the Balentines had not filed for bankruptcy within the previous 5 years. An application listing a bankruptcy filing within the previous 5 years would have been denied automatically by the system, pursuant to GeoVera's underwriting guidelines.
3. The application was not signed by the Balentines. All applications must be signed under the GeoVera underwriting guidelines.

After determining that the application's deficiencies could not be attributed to the Balentines, GeoVera paid the Balentines in excess of $780,000 on their claim. GeoVera then brought claims against ECA and Reeves for negligence, breach of fiduciary duty and constructive fraud. The parties settled these claims, and GeoVera released ECA and Reeves of liability. GeoVera also brought claims against Graham asserting, among others, breach of contract and negligence.

The Eighth Circuit Court of Appeals affirmed the grant of summary judgment to Graham on GeoVera's negligence claim. However, because it found that the agreement between GeoVera and Graham placed a duty on Graham to apply GeoVera's underwriting guidelines to all applications for insurance submitted by its retailers under the terms of the contract, the Eighth Circuit reversed and remanded for further proceedings on GeoVera's breach of contract claim.

Both GeoVera and Graham moved for summary judgment. The district court denied GeoVera's motion and granted summary judgment to Graham on GeoVera's claims for breach of contract and negligence. GeoVera then filed a motion for reconsideration, which the district court denied.

Related: Read Zalma's previous column, "Cancellation to litigation".

GeoVera and Graham agreed that Graham "had no part" in submitting the Balentines' application. GeoVera asserted, however, that the agreement placed on Graham a duty "to make certain that only applications that complied with GeoVera's underwriting guidelines were submitted to GeoVera," including applications submitted by the retailers appointed by Graham. Graham responded that the agreement does not create any obligation for Graham to apply the underwriting guidelines to applications submitted by the retailers or to supervise the retailers to ensure that they submitted only applications that satisfied the underwriting guidelines.

The Eighth Circuit agreed with GeoVera that the agreement places a duty on Graham to apply GeoVera's underwriting guidelines to all applications for insurance submitted under the terms of the Agreement, including those submitted by retailers appointed by Graham. Under Article II, Section (B)(2) of the Agreement, Graham had the responsibility "[t]o apply written underwriting and rating guidelines prepared by [GeoVera] which have been provided to [Graham], and as may be revised by [GeoVera] from time to time, and to deliver policies, provided the risk falls within the acceptable underwriting criteria." This provision unequivocally placed a duty on Graham to apply GeoVera's underwriting guidelines to all applications for insurance submitted under the terms of the agreement.

Arkansas law requires that, "[i]n considering the different clauses of a contract, [courts] must read the whole document together and determine whether all parts are in harmony." Travelers Indem. Co. v. Olive's Sporting Goods Inc., 764 S.W.2d 596, 599 (Ark. 1989). Reading the agreement as a whole, the court agreed with GeoVera because no facial inconsistency required Graham to apply GeoVera's underwriting guidelines and allowed the retailers direct access to GeoVera's system.

Contrary to Graham's argument, granting system access to the retailers in and of itself does not mean that Graham could not have applied GeoVera's underwriting guidelines to applications submitted under the terms of the agreement. Initially, Graham could have insisted that its retailers send an application for insurance to it for review and approval before submitting the application to GeoVera. Moreover, the agreement makes clear that, after a retailer completes an insurance application, the system would provide a quote response to Graham and the retailer. This, in addition to the daily reports produced by the system and sent directly to Graham, would have put Graham on notice that one of its retailers was in the process of submitting an application. Graham then could have worked with its retailer to verify that the risk to be insured fell within GeoVera's underwriting criteria before the policy was issued.

The court concluded that the agreement placed a duty on Graham to apply GeoVera's underwriting guidelines to all applications for insurance submitted under the terms of the agreement, including those applications submitted by the retailers appointed by Graham.

Lessons learned

Although a substantial profit can be garnered for the insurer and the surplus line broker from the type of agreement that GeoVera and Graham entered into, it must be fulfilled to the letter to avoid an errors and omissions claim. In this case, the Graham signed up retail brokers to write insurance but failed to police the work of the retail brokers.

Clearly, had the true facts been represented at the time of the application, insurance never would have been written and, because GeoVera's investigation established no intent to deceive on the part of the insureds, the insurer was compelled to pay a claim of $780,000 it would not have owed. It sought recovery from all involved, settled with some, and went forward against Graham. The Eighth Circuit concluded that there was sufficient evidence to raise an issue of fact to be decided by a jury and the case was returned to the trial court to determine if there was a breach and the amount of damages, if any, GeoVera is entitled to receive from Graham.

Related: Read Zalma article, "The law of unintended consequences".

If this case was in California or New York, the "Marine Rule" would allow rescission of an insurance policy for an innocent misrepresentation or concealment of material fact. Because the misrepresentations were material in a state like California or New York, the policy would have been rescinded, premium would have been returned and the insured would have brought suit against the agents and brokers.

In either case, the surplus line broker and retain broker were on the hook for damages.

This case teaches that a surplus line broker that takes the pen from an insurer must fulfill every condition of the contract of insurance or suffer not only the loss of a profitable contract but find it is compelled to pay damages to the insurer.