Understanding an Agent's E&O Risks When an Insurer Becomes Insolvent

According to Higginbotham & Assoc. v. Greer, 738 S.W.2d 45 (Tex. App. 1987), a leading case on insurer insolvency and the liability of an insurance agent or broker, the general rule is that an insurance agent or broker is not a guarantor of the financial condition or solvency of the company from which he obtains the insurance. He or she is required, however, to use reasonable skill and judgment with a view to the security or indemnity for which the insurance is sought, and a failure in that respect may render him or her liable to the insured for resulting losses. 

Thus, where a policy is procured in a company known to be insolvent, the agent is liable for a loss suffered by reason of such insolvency. On the other hand, where the company was solvent when the policy was procured, its subsequent insolvency generally does not impose liability on the agent or broker. In Greer, the court held that:

[A]n agent is not liable for an insured's lost claim due to the insurer's insolvency if the insurer is solvent at the time the policy is procured, unless at that time or at a later time when the insured could be protected the agent knows or by the exercise of reasonable diligence should know, of facts or circumstances which would put a reasonable agent on notice that the insurance presents an unreasonable risk.

Accordingly, it is imperative that insurance agents or brokers determine that the insurer is presently solvent when placing the insurance. This is especially true for any new companies with which you are contracting.

Some courts have found that an agent also has a duty to determine that the insurer is licensed in the state or complies with the surplus-lines statutes for the state. Good E&O loss control practices call upon insurance agents and brokers to perform such an analyses across the board. The prudent insurance agent or broker will also investigate the excess and surplus lines broker utilized and obtain a copy of their E&O policy.

Some courts have held insurance agents and brokers liable for failing to consider and inform the insured of the effects and potential risks of obtaining insurance from an unlicensed carrier. See, for example, Al's Café, Inc. v. Sanders Ins. Agency, 820 A.2d 745 (Pa Super. Ct. 2003), in which the court held an insurance agent had a duty to advise the insured that by failing to use an insurer licensed in Pennsylvania, the insured was forfeiting the protection—should the insurer be placed into insolvency—of up to $300,000 made available to insureds of Pennsylvania-licensed casualty insurers by the Pennsylvania Property and Casualty Insurance Guarantee Association, and a defense to claims made against the insured.

Insurance agents and brokers should advise their insureds in writing as to why the nonadmitted or unauthorized insurer is being selected, what they know about the insurer's financial condition, and note that the state's guaranty fund will not respond if the carrier becomes insolvent. The Big I has a form Excess and Surplus lines waiver letter for reference. Agents and brokers may also wish to consult with their E&O carrier or E&O counsel to obtain such forms in compliance with the particular laws in a given state.

Although a majority of courts have found no continuing duty to monitor the solvency of the insurer, a minority of courts have held that an agent has a duty to inform an insured if the agent is aware or reasonably should have been aware of a subsequent insurer insolvency. See, for example, Kinder Mortgage Co. v. Celestine, 635 So.2d 527 (La. Ct. App. 1994), in which a broker "had reason to suspect [insurer] would become insolvent, yet did not notify customers or attempt to find suitable replacement coverage.

In states where insurance agents and brokers have a duty imposed to monitor the solvency of insurers, whether imposed by common law or statute, they must exercise reasonable care, skill and diligence. One or more reductions in the insurer's A.M. Best's rating in the last three to five years is a potential indicator of financial difficulty. But A.M. Best is only one source of information to evaluate the insurer's financial condition. There are a number of other potential financial difficulty indicators in the areas of: 

• Market conduct (e.g., attempted large-scale mid-term cancellations).
• Underwriting and pricing changes (e.g., dramatic increases/decreases in agency binding and/or underwriting authority).
• Agency/company transactions (e.g., cash flow problems, slow return of unearned premiums, commissions, etc.).
• Claims handling and loss reserving (e.g., denials of obviously covered claims).
• Organizational changes (e.g. suspicion of fraudulent or criminal activity).
• Financial conditions/performance (e.g., abnormal results on four or more NAIC tests).
• Third-party information (e.g., coverage refusals by umbrella/excess carriers over company's primary coverage).

In those states where an insurance agent or broker has no duty to monitor the insolvency of insurers with which they have placed business, the agency or brokerage may make a business decision to nonetheless do so for its clients. If the agency or brokerage assumes this duty, it should exercise reasonable care, skill and diligence.

The general E&O maxim, "There are no second-class citizens/clients of the agency," applies here. If you are going to monitor the financial condition of insurers and advise only your "best clients," you are creating an E&O exposure for those clients who do not receive such advice. 

In instances where the financial condition of an insurer declines significantly, the prudent insurance agent or broker will inform insureds in writing and offer the option, where applicable, of insuring through a more financially stable insurer. When discussing the topic of insurer-insolvency risks, the "state guaranty funds" will invariably come up. Insurance agents and brokers should fully familiarize themselves with their state's guaranty funds. These funds typically have territorial limits. For example, in New York and Pennsylvania, the funds only apply to policies issued by an insolvent domestic insurer, or a foreign or alien insurer licensed to do business within the state.

There are also monetary caps on the amount the funds they will pay out per claim. For example, Pennsylvania's cap is $300,000 per claim. Moreover, state guaranty funds have short time frames within which an insured may file a claim. In the event of an insurer insolvency, insurance agents and brokers with impacted insureds should promptly contact their E&O counsel and insurers, as well as state associations for guidance.

The insurance agent's last line of defense with respect to E&O loss control for claims arising out of insurer insolvency is the agent's own E&O policy. Be sure yours has sufficiently high limits. Be mindful that E&O carriers, as initially influenced by reinsurers, place insolvency endorsements in E&O policies that provide coverage but excludes coverage where the agent places business with an insurer rated below a certain level, such as a "B+."

The phrase "at the time of placement of such coverage" in such endorsements may be interpreted to mean not only when the policy was initially procured, but also at the time of renewal. Accordingly, insurance agents and brokers should diligently check ratings each year. Once again, in the event that a rating change occurs, agents and brokers should minimize a potential E&O exposure by sending the insureds a letter advising of the insurance company rating downgrade and offering the opportunity to submit an application to another insurer. Agents and brokers may consult with their E&O counsel and E&O insurers for sample downgrade letters.