Inherent WC Conflicts: Additional Retro Premiums, Claims Handling Issues
By Diana Reitz
From the August 19, 2003 issue of National Underwriter—Property & Casualty edition
One of the most frequently contested issues in workers compensation case law involves the inherent conflict of interest that exists when an insurance company is paying claims with someone else's money.
This occurs in risk-sharing workers comp programs, such as retros and large deductibles, when the insured shoulders at least part of the financial burden of claims.
Even a casual review of workers compensation litigation unveils a myriad of situations in which corporate insureds have contested—or refused—to pay additional premiums that are based on paid and/or reserved losses as established by their insurers.
The reasons? The premium was supposed to be capped and guaranteed instead of floating based on loss experience. The insurer failed to act in good faith and reasonable competence in its handling of claims. Or the premium agreement was an illegal “side agreement” that violated a state insurance code.
Do these cases arise because corporate insureds really don't understand what they're getting into when they sign up for such plans?
Or were their insurers really that careless in handling claims or, worse yet, engaging in illegal and unethical schemes?
Many of the cases involve retrospectively rated programs from years ago, but the reasoning espoused in them offers valuable guidance to corporations now being written on risk-sharing programs.
Perhaps the first lesson is that, if it seems to be too good to be true, it probably is.
This is the adage that the appeals court pointed out in the case of Wal-Mart Stores, Inc., v. Crist. This 1988 case involved the suppression of payroll (something that hopefully no longer is done) in order to develop an artificially low guaranteed premium.
The policy was written by the now defunct Transit Casualty Company through a Texas intermediary and Alexander & Alexander, Wal-Mart's broker.
Under the program sold to Wal-Mart, all employees were to be covered for workers compensation for a $3.5 million premium, well below the $19.9 million premium that the correct payrolls would have developed.
The trial court ruled that Wal-Mart was a “willing and knowing participant” in an illegal venture that featured an undervalued payroll. The appeals court, however, reasoned that, given the soft market conditions of the time and its previous loss history, Wal-Mart could have reasonably believed that the $3.5 million premium did meet state requirements.
Despite this, the appeals court ruled, Wal-Mart should have taken corrective action once the policies were delivered and it realized that the payrolls were so dramatically suppressed.
The result of this case? Both the corporate insured and the insurer were responsible for the illegalities.
The workers compensation premium agreement was voided. Since there was no valid premium agreement, the coverage also was unenforceable.
As the court noted, Transit had already paid between $16 and $21 million in claims over two policy terms. A significant number of claims remained outstanding, and Wal-Mart was held ultimately responsible to pay for those remaining losses.
Another frequent theme of such cases is the belief, which many risk managers argue today, that they should be able to influence how workers compensation claims are handled when it's their money that's being used to pay the claims.
Some jurisdictions have sided with these insureds, stating that their insurers risk being called to task for failing to use good faith and reasonableness when spending their insured's money. Others refuse to accept the arguments made by these corporate insureds after their workers comp programs have gone south.
One such case involves the issue of which party must prove that the insurer either did or did not act in good faith when handling claims.
The 1993 case is Port East Transfer v. Liberty Mutual Insurance Co.
Port East refused to pay retrospective premiums, alleging in general that Liberty Mutual had failed to exercise good faith and reasonableness in handling its claims.
The appeals court stated, “Liberty Mutual was confronted with potentially conflicting interests when it handled claims against Port East that were covered by a retrospective premium policy…there may have been a temptation toward generosity when the insurer's fee increased with each dollar paid out.”
“On the other hand, these circumstances were apparent to these two sophisticated business entities when they entered into the contract.”
The court placed the burden of producing evidence that Liberty had violated an implied condition of good faith upon the corporate insured. Only after such evidence had been produced did the insurer have to prove it had acted reasonably.
Then there are the cases that allege illegal “side agreements” had been used to skirt state laws governing insurance practices.
This type of situation arises after a seemingly pro-insured premium agreement is negotiated, only to have the program blow up in a way that no one expected.
An unpublished case decided in April 2003 illustrates this type of argument.
In Wayne Duddlesten, Inc., v. Highland Insurance Co., Duddlesten claimed that Highland had inappropriately settled and paid several claims. Duddlesten refused to pay retro premium adjustments of more than $300,000.
The appeals court ruled that there was no language in the policy giving the insured specific input into claims management, continuing that “we are not permitted to write such a clause into the policy.”
In addition, even though the premium payment agreement was not identified in the application for the policies, it was included within the policies. Therefore, it was not a “side agreement” that violated state insurance law.
Another frequently voiced misunderstanding is that retro and other risk-sharing plans are automatically closed after a specified period of time.
Not at all true.
These plans remain open until all claims are settled and paid or the involved parties mutually agree to close them.
The 2002 case of National Union Fire Insurance Co. of Pittsburgh v. LSB Industries, Inc., illustrates this point.
In this case, LSB and National Union's disagreements over premium adjustments were well documented, including claims handling, amounts paid, settlements, reserve calculations, and premium calculations.
As a result, LSB didn't pay certain adjustment billings.
After a number of years, the two parties resolved all but one disagreement: whether the Oklahoma statute of limitations barred any part of National Union's claim.
The Tenth Circuit Court of Appeals ruled that interim premium adjustments were not installments on the same debt but, rather, valuations that simply measure loss reserves.
They are separate and distinct from the “final payment,” and the Oklahoma statute
of limitations was not triggered until the final premium was calculated.
Since the final premiums on the 1985 and 1987 policies had not been calculated until mid-2000, the payments were not barred by the statute of limitations.
These cases involve risk-sharing plans that were negotiated years ago, but many of the contentious issues we see in them still exist today.
They also point out that what may seem like a great deal today may turn into a source of disagreement and litigation for years into the future.
At the least, corporate insureds should heed the words of many courts:
Sophisticated businesses are expected to understand the risk-sharing programs they negotiate and may be held to a higher standard than less sophisticated enterprises that rely solely on the word of their agent or broker.