Insurance in Times of Financial Crisis

The current financial crisis affects almost every aspect of our business life — that includes insurance. Businesses need to be wise consumers and aware of the legal issues covered by their coverages. Let’s take a look at employment practice liability, directors and officers liability, and fiduciary liability insurance.

Employment Practice Liability Insurance

The number of employment-related lawsuits has significantly increased, and award levels in this area are setting records. It has been estimated that there are more than 150,000 wrongful employment practices complaints currently filed with state agencies across the nation and the Equal Employment Opportunity Commission. With the large rise in claims, it may not be good business judgment for a company to rely merely upon loss-control techniques like a thorough employee handbook or a “zero tolerance” policy.

EPLI coverage usually works with a deductible so that smaller, expected claims do not generate adverse loss on the policy and generate higher premiums at renewal. Instead, the policy protects the company from significant financial loss from large, unexpected claims.

EPLI covers discrimination, sexual harassment, breach of contract, defamation, whistle blower, retaliation, negligent hiring, negligent supervision, and negligent retention. The EPLI policy usually comes in two forms: (1) a named perils form — provides coverage only for exposures arising from events or legislation specifically named in the policy; and (2) “all-risks” form — explicitly covers all categories of employment suits. Not all EPLI policies cover third-party harassment or discrimination claims, so if a client wants such coverage, be sure the EPLI policy specifically covers it.

EPLI policies generally exclude intentional conduct from coverage. This is often an issue with sexual harassment claims, but usually the exclusion only pertains to violations that are proven to be intentional or deliberate by a judgment or other final adjudication.

Most EPLI policies give the carrier the right to select defense counsel, but companies often have their own lawyers that are familiar with the company’s owners, employees and daily operations. The Texas Supreme Court has upheld policy provisions allowing the insurer to conduct the defense, including the right to select which attorney will defend the claim. See State Farm Mut. Auto Ins. v. Traveler, 980 S.W.2d 625, 627 (Tex. 1998). However, the insurer’s contractual right to control the defense (and therefore the right to select counsel) is, in effect, overridden by the common law where a conflict of interest exists between the insurer and the insured.

There are two general views on when an insured-insurer conflict of interest exists if the insurer reserves its right to deny coverage. The minority view is that there is a conflict of interest anytime the insurer attempts to reserve its right on a question. Ranger Ins. Co. v. Rogers, 530 S.W.2d 162, (Tex.Civ.App.-Austin 1975, writ ref’d n.r.e.). This approach, also known as the “automatic conflict rule,” is criticized by many commentators as being superficial. The majority of courts adopt the view that a reservation of rights does not always create a conflict of interest. See Windt at 371.

More recently, in Northern County Mutual Insurance co. v. Davalos, 140 S.W.3d 685 (Tex.2004), the Texas Supreme Court began moving away from the automatic conflict rule and saying a conflict of interest between the insurer and insured allows the insured to control the defense while the insurer remains liable for the reasonable costs of that defense. But when the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends, the conflict of interest will prevent the insurer from conducting the defense.”

An insured that is concerned about this issue should negotiate with the carrier to put language into the policy that the insured can choose defense counsel at rates commonly used by the carrier. If a client is already in litigation and the insurer is providing a defense under a reservation in which the facts to be adjudicated are the same as the facts in the coverage dispute, then the client may have a good argument that it has the right to retain the defense counsel of its choice.

Fiduciary Liability Insurance

Fiduciary liability typically involves an employee suing an employer for not offering employee options for investing in a 401K plan, and the law weighs heavily in favor of the employee in these cases. ERISA protects the interest of plan participants and their beneficiaries, and defines the liabilities and responsibilities associated with the management and administration of an employer’s health and welfare, pension, profit sharing and other employee benefit plans. COBRA and the Retirement Protection Act of 1994 create additional compliance issues for fiduciaries. Finally, the increase in employee stock ownership plans creates significant liability for fiduciaries.

A fiduciary liability policy can provide coverage for two broad areas:

Fiduciary liability insurance is appropriate for any company that sponsors a retirement plan, such as a defined benefit plans (i.e. health and accident plans), regardless of the company size or number of plan participants.

Directors & Officers Liability Insurance

D&O insurance covers a range of indiscretions under the auspices of the term “wrongful acts.” The term is usually defined to include actual or alleged errors, misleading statements, and neglect or breach of duty. Coverage is narrowed by a list of limitations and exclusions.

D&O polices protect companies and their directors and officers from liabilities arising from actions taken by the directors and officers themselves in their corporate capacities.

A D&O policy will usually cover:

Not all policies will cover intentional wrongdoings. For example, if a company is found liable for intentionally failing to disclose or intentionally and wrongfully obtaining monies, then its D&O policy may not cover such a claim. Coverage will most likely be determined by the definition of “loss” under the policy.

Recently, there has been an influx of declaratory judgments and rescission actions by insurers to rescind policies due to misrepresentations or omissions in insurance applications. Typically, before an insurance policy is created, a D&O insurer will require various types of financial information through an application process. The insurers need to review financial statements, annual reports, corporate bylaws and claims history. An insurer will rely on this information in evaluating risk and determining policy premiums. It is important that each document submitted to the insurer is accurate and that any forms filled out by corporate representatives are truthful. If any of the information the insurer relied upon in drafting the policy is found to be false or misleading, the policy could be rescinded as to every insured.

Another concern is the Sarbanes-Oxley Act (SOX) signed into law in 2002. Its purpose is to protect investors by improving the accuracy and reliability of corporate financial reporting. SOX creates an independent auditing-oversight board under the Securities Exchange Commission; imposes white-collar criminal penalty enhancements for criminal fraud offenses; provides for enhanced and more extensive corporate financial disclosures and reporting; and creates an enhanced recourse procedure and safeguards for those harmed by securities fraud.

Although SOX provides for heightened exposure to civil liability, the more threatening aspect of SOX is its criminal penalties. White-collar criminal penalties for corporate officials include: (1) increasing the maximum penalty for securities fraud to 25 years in prison; (2) increasing possible CEO and CFO penalties to a $5 million fine and a 20-year prison term for issuing false statements to the SEC or for failing to certify financial reports; (3) increasing maximum penalties for mail and wire fraud to 20 years; (4) increasing maximum penalties for defrauding pension funds to 10 years; (5) requiring the preservation of key financial audit documents and e-mail for five years and imposing a 10-year felony for destroying these documents; and (6) imposing a maximum 10-year prison term and/or monetary fine for intentionally retaliating against corporate whistle-blowers.

Further, a corporation looking to cover the risks created by SOX should be aware of the “insured v. insured” exclusion. Usually, these exclusions will state that certain claims are covered as long as they are not brought with the solicitation or assistance of any director or officer of the company. Generally, this provision will pertain to former officers and directors as well as current ones. Therefore, if a corporation lets a director go and he solicits or assists in a claim against the company, that claim will probably not be covered because of the insured versus insured exclusion.

The insured v. insured exclusion was initially designed to eliminate coverage for struggles over organization control, which can be intractable. This exclusion may eliminate coverage for employment-related suits. If the nonprofit’s executive director is insured under the policy, his or her wrongful termination claim against the board members would be excluded by the insured v. insured exclusion.

As we work through this financial crisis, we will see how courts deal with the increasing claims against businesses and financial institutions, and likewise how the insurance coverage issues raised by the crisis impact insurers. Following the trends should allow agents, brokers and carriers to give proper and timely advice to insureds.