October 1, 2005 by Craig Harris
If anyone should know about the relationship between insurance premiums and claims, it should be property and casualty insurance brokers. The same could be said for the importance of loss prevention and risk management.
And yet, over the past decade, brokers have been served with a spate of lawsuits – particularly during the consolidation frenzy of the late ’90s. These legal actions relate to dereliction of professional duties in both personal and commercial lines, ranging from inadequate coverage and misrepresentation to delays in processing. Consumers, whether in personal or commercial lines, are showing an increased willingness to dispute denied claims and fight for their insurance money.
“E&O claims are increasing because we live in a more litigious society, and consumers are more aware of their rights,” Jim Bonnay, president of Bonnay & Associates and a specialist in professional liability for brokers, says. “Clients expect broader coverage and the idea when they hear ‘all-risk’ (policy) is that absolutely everything is covered. If something is not covered, it must be the broker’s fault and there is the tendency to get lawyers to make a case out of something.”
“Brokers are becoming more and more of a target,” Rod Finlayson, executive vice president of the CG&B Group, a brokerage that places E&O business for Employers Reinsurance Corporation (ERC), says. “I could speculate that part of that is to do with the insurance industry’s recent decline in public popularity.”
TOUGH TIMES FOR E&O
The bottom-line result is that professional liability carriers, of which ERC and Encon are the two largest, have been hard-pressed to sustain profits in this particular class of business in recent years. Only this year have signs of stability emerged in broker’s professional liability.
“We entered this line in 1989, and from that point until 2001 we did not report a profit in any given underwriting year,” Michel Yip, the managing director of Encon, says. “In some years, our loss ratio was as high as 150%.”
“This was a deteriorated book of business from a performance standpoint in the early years of this decade,” Finlayson adds. “During the course of a long soft market, overall rates had become quite depressed.”
The writing was on the wall for significant rate increases in broker E&O coverage well before September 11, 2001. But the impact of that event on reinsurance costs spurred dramatic price hikes in professional liability coverages of all stripes over the past four years. For brokers, who are required to carry mandatory E&O coverage in all Canadian provinces, this means they were forced to ride out a tight market.
“It has been a struggle to increase rates – much to the chagrin of brokers, I’m sure – but this line of business is back to being profitable,” Finlayson says, noting rate increases of 100% were not uncommon during 2001-2004.
“As far back as 1999, we started to give substantial rate increases, re-underwrite accounts that had more than one loss and impose larger deductibles,” Yip says. ” Brokers are the first to complain on behalf of their clients, but they are also knowledgeable about the market and they understand why their premiums are going up. A lot of them have started working on risk management.”
Risk management has weeded out some of the more glaring examples of E&O claims evident in the ’80s and ’90s, according to Barry Papazian, a partner with the law firm Papazian, Heisey, Myers and a specialist in broker professional liability. “Brokers have learned a lot through various E&O educational programs,” he says. “The obvious stuff doesn’t happen anymore.”
Brokers act as “dual agents,” in that they have a duty to the client, but also to the insurer. According to Papazian, an insurance broker’s liability may be based on contract, tort or as a fiduciary, depending on the circumstances. If a legal action is related to denied coverage, insurance companies often “crossclaim” against the broker, Papazian says. This could be for an allegation that the broker exceeded his or her actual authority, or failed to make full disclosure of material facts, affecting the insurer’s judgment of the risk.
The legal actions of clients, however, arguably cause the greatest concern and cause of liability for brokers. Bonnay notes that “inadequate coverage,” which may involve a client having not enough coverage or no coverage at all, accounts for about one-third of all E&O claims against brokers.
THE LAW AND E&O
Two leading cases enunciated principles of insurance broker responsibility to clients – Fine’s Flowers Ltd. et al v. General Accident Assurance Co. of Canada (1977) and Fletcher et al v. Manitoba Public Insurance Co (1991).
Fine’s Flowers involved a greenhouse operator who submitted a claim when water supply to the boilers, which heated the greenhouses, failed. The resultant freezing of the greenhouses caused damages. Whereas the boilers were specifically covered by the policy, the pumps that failed were not; consequently, the insurer successfully denied coverage. The greenhouse owner originally asked the broker for “full coverage” and the “best coverage,” which was construed at trial to require coverage for all foreseeable, insurable and normal risks relating to the greenhouse business. The Ontario Court of Appeal reversed a previous court ruling and ruled in favour of the plaintiff.
In Fine’s Flowers, Ontario Court of Appeal justice Bertha Wilson (as she was at the time) adopted what Papazian refers to as “the intelligent insurance agent test,” formulated in an earlier court decision. “The solution lies in the intelligent insurance agent who inspects the risks when he insures them, knows what his insurer is providing, discovers the areas that may give rise to dispute and either arranges the coverage or makes certain the purchaser is aware of the exclusion,” Wilson wrote. This effectively raised the bar higher for a broker’s duties of care.
In Fletcher, the Supreme Court of Canada found employees of Manitoba Public Insurance (who were compared to private insurance agents) liable for not recommending the Family Protection Endorsement to Mr. Fletcher, who had applied for auto insurance. This endorsement afforded a family protection if an at-fault motorist was inadequately insured.
Papazian notes that Fletcher was “built on the fact that brokers are holding themselves out as professionals. The finding said: ‘Look if you want to be a professional, you can’t just take instructions, you also have to counsel and advise.'”
The higher standards and duties of care to which brokers were held unleashed a torrent of active litigation. The litigation likely reached a peak in the late ’90s, but continues today. As brokers become more arms-length and independent from their insurance companies, they are likely going to be included in more lawsuits.
“There is a lot of litigation against insurance companies,” Papazian says. “There’s no doubt that brokers get involved whenever there is an ‘off-cover’ position taken by an insurer. It is almost the fear of trial lawyers not to include every party who may have had something to do with ‘making the soup.'”
HIGHER E&O DEDUCTIBLES EXPLAINED
And this has affected the E&O coverage available for brokers. Papazian notes that roughly 50% of all broker E&O litigation is settled with no or minimal payouts, which is relatively low compared to the 85-90% payout rate for all general litigation. Yet brokers drawn into insurance lawsuits still have to carry what he calls “significant” defence costs. This is one reason why higher deductibles for defence costs have been introduced into most E&O policies.
Also, the type of litigation has changed in the past two or three years, according to Papazian. “Auto insurance was initially a huge area of E&O litigation, but there is much less of it today,” he says. “One of the tr
ends I see now is an uptake in claims in commercial lines – especially regarding financial valuation, coinsurance and business interruption insurance. These are often more difficult because of the financial complexities and because accountants have to be involved.”
Legal actions against brokers often relate to nuances of policy and can be difficult to predict. “It is the grey situations that are more difficult,” says Finlayson. “These involve asking questions such as: ‘Does the client fully understand this coverage?’ There may be cases where it would be better for the broker financially if the client purchased the coverage. Here, the broker has to take his wallet off the table and think about what is right for the client, regardless of what the financial impact is.”
Some sources note the problem with E&O claims today is severity, not frequency. “There has been a lesser frequency in our book of business over the past four years, but the severity is growing,” Yip says. “We are measuring severity of E&O claims year over year at about 10%, which is not good.”
Yip attributes increased claims severity to “the turmoil over the past four years and the rates going up. Brokers were being asked to remarket a lot of business, and often the client doesn’t get 100% of the coverage he got in the prior market. As soon you get a claim and it is not covered under the new policy, the broker is brought into it.”
TIPS TO AVOID CLAIMS
To prevent – or at least minimize – E&O claims, sources advise brokers to focus on several areas of their day-to-day operations.
“The number one rule is standard practice,” Finlayson says. “In other words, everything in an office should have a procedure that is thought out by management, and that procedure should be published in the office and mandatory for everyone to follow – no exceptions. In a claim, we have to show that you do in fact have standards of practice and that they are followed. This is a powerful defence.”
Another oft-cited area is documentation. “The best defence against an E&O claim is a well documented file,” Bonnay says. “For brokers, if you quote, make a note.” Yip adds: “Most of the time when we have to pay out a claim, there is a lack of proper documentation in the broker file.”
The importance of documentation and standard practice is becoming particularly clear in commercial lines, according to Papazian. “In personal auto and home insurance, you have the formal process of an application,” he says. “In commercial you don’t, and there is a ‘casualness’ to the process. In the majority of commercial line placements, there is a phone call, a memo or an email, with few formal, signed applications. If I were looking at how to fix things a bit, I would impose a system of more formality on the commercial lines placement process.”
As more brokers follow these risk management rules of standard practice, consistency and documentation, Finlayson says the E&O market should become more stable.
“After an unbelievably tight market, there is more stability returning,” he observes. “And we are adjusting prices to reflect that reality. If the last market proved anything, it demonstrated the importance of stability in terms of insurers that stayed and peripheral ones that left. And I would say that this stability has a cost.”