Underwriting vs. Coverage Standards

Historically, if an account met an insurance company’s underwriting standards, the account was provided coverage in exchange for the required premium. Sometimes insureds and/or agents lied about the account actually meeting those standards, which would only be discovered after a claim was filed. The carrier would then determine whether they would deny coverage.

The denial of claims in these situations is understandable and reasonable. I have never experienced nor even heard of any contentiousness when these claims were denied with the exception of some agents screaming bloody murder that they should not be penalized (i.e., having their contract pulled or suffering an E&O claim) for purposely misleading the insurance company.

More recently though, carriers have begun to institute risk management standards with which insureds must comply throughout the policy term. Moreover, some carriers have begun denying claims for failure to comply with the required standards even in situations where the standards have absolutely nothing to do with the claim. For example, the fire extinguishers do not meet the standard, but the loss is caused by water. Or perhaps the insured is not complying with MFA cyber standards, but the loss would not have been prevented had the insured complied because the loss had nothing to do with MFA protections.

I am pretty sure these coverage denials will not improve the industry’s image. The worse the industry’s image becomes, the less insurance people will purchase, and the more regulators will make life harder for insurance companies. Overall, I do not think these coverage denials are a good strategy, but carrier executives make a lot of money, so I am sure they are correct.

At the agency level, the changes in standards mean a decision needs to be made relative to what kind of agent you want to be going forward. Historically, an agent’s lowest standard of care required insureds to read and understand their policies without the expectation that the agent will explain much of anything.

However, these risk management requirements can override coverages.

What used to be limited to warranty applications is becoming far more widespread and is making a much larger portion of policies de facto warranty applications. Cyber is probably the best example of this situation because for all practical purposes, cyber applications should be considered warranty applications.

The term “warranty application” might be new for some readers. Essentially a warranty application is a statement that all the information provided on the application is warrantied by the insured to be correct. If the statements prove to be incorrect, coverage can be voided.

Technically all insurance applications could be considered warranty applications, but that is not how carriers have treated them in the past. For example, tens of thousands, maybe hundreds of thousands of personal auto policies are rated on a personal use basis of less than the three miles when the insured is actually driving much further to get to work. However, despite this disapprobation, I have never personally heard of a claim being denied when that driver had an accident. The worst I have seen when the agent/insured committed gross misinformation was the carrier charged an additional premium for all the lost rate they would have gained had correct data (i.e., honest data) been provided.

However, carriers are starting to deny claims in some instances in these situations. I understand their point when the misinformation/misrepresentation is directly applicable to the claim, but not otherwise. It seems unfair especially when application questions are worded so poorly.

Again, I will use cyber applications as an example, but these wording issues can be found in many other coverages. The application question is written with only a “Yes/No” option. The question cannot be answered honestly and correctly as “Yes” or “No.” Neither answer is correct.

A great example is a cyber application that asks if the insured is in compliance with privacy laws. The question should list the specific laws. The insured might be in compliance with some privacy laws and not others.

Most insureds are not aware of all the privacy laws that exist, so they cannot honestly answer this question correctly without significant assistance from their attorney and their IT providers/executives.

Answer this question incorrectly, suffer a claim, and then learn all coverage is voided. The insured then asks, “Why buy insurance if they’re not going to pay my claims when I tried to answer the questions as honestly as I know how to do?”

The traditional property insurance world is moving in this same direction. Requiring an exact listing of the executives and requiring that the carrier be notified of changes in executives, fire control systems, and even fire extinguisher standards, are common examples whereby carriers have denied claims for failure to comply with policy standards and/or answering an application question incorrectly even though the claim had nothing to do with the question.

I am not sure what good peddlers of insurance can do in this more restrictive environment. Peddler agents make the industry look worse as claim denials grow and they hide behind low standards of care. Insureds need advice, not excessively restricted insurance policies sold by agents who have limited knowledge of coverages and coverage restrictions, and who basically sell insurance on a caveat emptor basis.

First-rate agents have an excellent opportunity in this otherwise desultory environment to shine. Understanding that carriers are denying claims in this fashion hopefully motivates the best agents to talk to their insureds throughout the year, reminding them of the need to maintain policy standard compliance throughout the policy period. It enables the best agents to tweak warranty applications in order to answer the questions correctly, rather than “Yes” or “No.” It also enables the best agents to assist clients with the inclusion of severability and non-rescission language in the policy.

This new environment enables the best agents to more fully protect their clients, and that is what agents should be paid to do. AI will handle straight procurement just fine and for 5% commissions.