A Few E&O Tips to Watch: Certificates, Carrier Ratings and Alternative Markets

It seems agencies today have more challenges than ever. Below are three tips to reduce errors and omissions (E&O) exposures.

I would love to share with you a story regarding a multinational company that demanded they be listed as an additional insured on dozens, maybe even hundreds or thousands, of certificates. Possibly they incur a loss of $1 billion. They might review all the thousands of certificates because they possibly did not have $1 billion of insurance coverage. (Who does?)

They might think it may be possible, and therefore they may want to learn, how much more coverage they could claim based on how many certificates named them as additional insureds.

Aghast you may be, but a company might conceivably discover several hundred million dollars of additional coverage and/or they might discover coverage under their agents’ E&O policies due to improper certificates. With $1 billion on the line, what do they have to lose versus how much they have to gain? They might think this was a strategy worth at least investigating.

Of course, this is all hypothetical, but because it has the possibility of reality, agents have an opportunity to act now. Here’s the kicker: What happens if the agent responsible for printing the certificates (printing including electronic) never submitted the certificates to their carriers? We all know the carriers do not want them.

What happens if the carrier learns, after the fact, they are potentially on the hook for a large claim (some portion of $1 billion) because they have an additional insured that is a multi-national, multi-billion company operating in a hazardous industry for which the carrier was never aware they were providing coverage as the agency did not provide a copy of the certificate? When claim dollars get large, do claimants, including insurance companies, remember verbal instructions or do they rely on whatever is required that best makes their case?

If you never send copies to the carrier, they can claim ignorance of the certificate. It puts them in a better defensive position when a claim is made and your defense can be weakened when the carrier claims ignorance. It is best to send copies of the certificates to your carriers, regardless of what they have told you. Don’t create a situation in which they can claim ignorance.

Send carriers your certificates regardless of whether they tell you not to send them. If they throw them away, delete them, incinerate them — who cares? It is their problem then. Do not try to protect your companies from themselves.

It is your responsibility to notify clients if a company is not rated or is rated poorly.

Even if the carrier is a benefits carrier, maybe the only material carrier in the state, and even if no other choice exists, the agency still has the responsibility to notify. The case law is clear even to a non-attorney like me. An agency does not have a choice but to notify. No distinction exists between property/casualty versus benefits versus life insurers either. Clients deserve notification.

Think of it from another angle: Why are companies rated if not to help protect consumers? Therefore, shouldn’t consumers be notified?

From a practical perspective, not necessarily a legal one (you would need to contact a highly specialized attorney or your E&O attorney to gain the legal perspective), some lines have higher standards than others. Surety is an example. So is life.

I do not know of any true total exceptions because even consumers placed with government backed, or in some cases, theoretically backed (it really does pay sometimes to read the fine print) insurance companies lacking adequate ratings, deserve notification.

Understand that not all insurance companies are the same financially. Obviously, we have had mutual companies and stock companies for 150 years. Material differences exist in their financial situations, balance sheets, ability to raise money and need to disperse profits, among other factors.

One structure is not inherently stronger than the other. It always comes down to how well the company is managed. From an E&O perspective though, assuming ratings are adequate, the industry has adjusted accordingly and relatively safely, if imperfectly over time to both kinds of organizations.

Today, it seems more companies are taking on alternative organizational formats such as reciprocals, risk retention groups (RRG), and captives (which in and of themselves are not generic by any means because many different kinds of captives exist).

Per A.M. Best Co. (http://www.ambest.com/resource/glossary.html), the following definitions give basic descriptions:

• Reciprocal Insurance Exchange — An unincorporated group of individuals, firms or corporations, commonly termed subscribers, who mutually insure one another, each separately assuming his or her share of each risk. Its chief administrator is an attorney-in-fact.
• Risk Retention Groups — Liability insurance companies owned by their policyholders. Membership is limited to people in the same business or activity, which exposes them to similar liability risks. The purpose is to assume and spread liability exposure to group members and to provide an alternative risk financing mechanism for liability. These entities are formed under the Liability Risk Retention Act of 1986. Under law, risk retention groups are precluded from writing certain coverages, most notably property lines and workers’ compensation. They predominately write medical malpractice, general liability, professional liability, products liability and excess liability coverages. They can be formed as a mutual or stock company, or a reciprocal.

I see agents regularly make what I consider to be a huge E&O mistake by not advising clients that reciprocals and RRGs are not typical insurance companies. They fail to explain that with a reciprocal, for example, the policyholder is agreeing to insure the other policyholders. The insurance company is not really a company but an administrator. Varying degrees exist but these are important distinctions because, let’s say a reciprocal company incurs a huge hurricane and calls upon its policyholders in other states to make the policyholders struck whole. I can guarantee the policyholders are not expecting a cash call. I can almost guarantee 90 percent of agents have not advised their clients of the call potential. To me, this is a potentially large E&O exposure. Disclosure is key.

Small captive insurance companies come in 100 different flavors, types, sizes and natures. The NAIC provides this definition:

Captive — An insurance company created and wholly owned by one or more non-insurance companies to insure the risks of its owner (or owners). Captives are essentially a form of self-insurance whereby the insurer is owned wholly by the insured. They are typically established to meet the risk management needs of the owners or members. Captives are formed to cover a wide range of risks; practically every risk underwritten by a commercial insurer can be provided by a captive. The type of entity forming a captive varies from a major multinational corporation — the vast majority of Fortune 500 companies have captive subsidiaries — to a nonprofit organization. Once established, the captive operates like any commercial insurance company and are subject to state regulatory requirements including reporting, capital and reserve requirements.

E&O exposures with captives are significant and depend on the agent’s role. If the agent is also involved in the captive, disclosure is required and likely a full explanation of the risks involved that goes beyond the standard risk disclaimer used by captives is required.

Another exposure is whether a captive is even an appropriate solution to the client’s needs. A captive is great when it fits the client’s needs and sophistication, but a large proportion of clients should never go into captives, or part of their risk is appropriate for captives but another part is not.

An agency recommending a captive had better understand captives deeply and also provide the education required to the client in writing.

Captives are rarely rated, and the fact the captive is likely reinsured does not resolve the issue (unless it is truly fronted). If the captive is not rated, this needs to be disclosed.

Another complication is that many insurance company executives and some regulators do not fully appreciate that not all reinsurance is created equal. Too many times I’ve heard people say, “Well, they are reinsured so all is good!” There are solid reinsurers, and some reinsurers that are not so solid. There are high reinsurance limits and low reinsurance limits. There are broad coverages and limited coverages. If an agent is going to rely on a captive’s reinsurance, or any carrier’s reinsurance, to address the lack of the captive or carrier possessing a rating, the agent should disclose the details of the reinsurance program. That may sound like a lot of work, but captives – and even some standard carriers – are designed for sophisticated buyers and agents.

If, as the agent, you are not sophisticated and knowledgeable enough to provide a reinsurance disclaimer, you probably should not be selling captives.

Innovation is great, but financial innovation is usually more complex than what already exists. Selling these innovative products as if they are simple is a huge mistake and an E&O bomb waiting to explode. It’s your choice if you want to sit on the bomb or disclose.

Note: None of the materials in this article should be construed as offering legal advice nor relied upon for eliminating or reducing the possibility of an E&O claim or incident. The specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.