The Never Pay Insurance Policy

Earlier this year, attorney John L. Watkins posted an entertaining and very informative series of blog posts about what a business should do if its insurer denies coverage for a claim.  Now, I know what you’re thinking.  “An attorney, huh?  Sure, that means an overly informative series of blog posts.  But entertaining?  Oh, come on, now!”  But really, as dry (and scary) as the topic may be, Mr. Watkins made it entertaining.  I mean, he even quoted Monty Python, for goodness sake.  The only thing I can figure is that his ability to make this topic entertaining must have something to do with the fact that he hails from Atlanta, Georgia.  Interestingly, he and I share similar professional backgrounds and, though located on opposite sides of the country, are seeing the same trends when it comes to insurers’ denial of insurance claims (both for an insured’s own property damage claims and, more scary, when it comes to defending and indemnifying insureds against liability insurance claims). 

At any rate, the posts, here, here, here, and here, are very good.  I couldn’t have said it better myself good.  So, rather than saying it myself, I’m pointing you in their direction.

In addition to the important points Mr. Watkins raises:

1.  Treat your insurance policies as if they were valuable financial documents, because they are.  Keep every piece of paper the insurance company sends you, in chronological order.  You will likely not receive a new copy of the entire insurance policy every year, so keep all of the documents you receive the first year the policy is in place (which will be lengthy, and should include declarations pages, coverage parts – sometimes in the form of a booklet – and endorsements) and then all of the documents you receive after that.  Keep them forever. 

2.  Read your insurance policies! Don’t wait until you have a claim (or a claim has been made against you). Insurance policies are notoriously difficult to understand, particularly when it comes to figuring out how the parts of the policy (the declarations, coverage parts and endorsements) work together. Get your coverage questions answered when you first receive a policy, not when you need it to respond to a claim, because then it’s too late to change your coverage if that’s necessary.

3.  Report claims or events which may give rise to a claim promptly.  Don’t do it by calling or e-mailing your insurance broker.  It’s okay to do that, too (certainly you will want to keep your broker “in the loop”), but your insurance policy or policies will have a section that tells you exactly how and where you are to send notices.  Do it that way.  Exactly the way the policy says you should. 

With respect to a claim against you by a third party (as opposed to a claim you may make to your insurer for damage to your own business property), provide your insurance policies to an attorney with knowledge regarding insurance coverage, and have the attorney decide which insurers to tender a claim to, and how.  Don’t assume which insurers should be notified (commercial general liability or professional liability insurer, current insurers or past insurers too), or whether or not the claim should also be tendered to your umbrella carrier.   

While we’re on this topic, the question of what is (or is not) a potentially covered third party claim is not always clear.  Certainly, if you are served with a lawsuit it should be tendered to the appropriate insurer(s) immediately.  But what if you receive notice of an administrative law hearing, or you receive a demand letter that threatens litigation in the future?  Again, this is when you need to consult with an attorney, since failure to notify an insurer when you should could deprive you of any coverage you would otherwise have had.   

4.  If you ask an insurer to defend you against a third party’s claim, and receive a reservation of rights letter (a letter from or on behalf of the insurer telling you that you will be provided a defense but the insurer reserves the right to contest coverage), take it very seriously.  If you haven’t already consulted an attorney by now, this is absolutely the time when you should.  A number of issues arise from an insurer’s reservation of rights letter, such as (depending upon your jurisdiction), your potential right to independent counsel (instead of, or in addition to, the insurer’s choice of defense counsel) at the insurer’s expense, and/or the insurer’s potential right to allocate the cost of some (or, given the outcome of the litigation, potentially all) of the defense costs incurred by the insurer to you (yes, that’s right, you could end up having to reimburse your insurer).  Statutory and case law applicable to these issues differs from jurisdiction to jurisdiction, so you will need the advice of an attorney who knows the law regarding insurance coverage and claims handling in your State.    

5.  Rather than (or in addition to) a reservation of rights letter, your insurer may ask you to sign a non-waiver agreement.  This document should be taken just as seriously as a reservation of rights letter.  More seriously, even.  Here’s why.  Generally, an insurer has the burden of identifying all potential grounds for denying coverage.  Failure to do so in its reservation of rights letter to the insured may be held to be a waiver of any grounds not identified.  Among other things, a non-waiver agreement typically is written in such a way as to avoid such a waiver.  Do not sign it until you have consulted with an attorney who is knowledgable regarding insurance coverage.

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Furthermore, a rose by any other name . . .

. . . may also bring a visit from the tax man (or woman).  Or the labor board.  Or a process server.

My previous “Rose By Any Other Name” posts have been about (a) misnamed/unnamed insureds and (b) contracts (verbal vs. written).  This post is about independent contractors who are really employees (at least, as far as the federal and state tax authorities are concerned), and other “thorny” employee classification issues.

At this time of rising State and Federal deficits, there seems to be an increased scrutiny of how small and medium sized businesses are classifying their workers.  In addition, attorneys who represent workers before the Labor Board seem to be experiencing an uptick in business, commensurate with rising unemployment.  This is strictly based upon anecdotal evidence (I’m receiving more calls from business owners on the receiving end of employee pay and benefit claims), but my suspicion is that such claims, as well as tax enforcement proceedings, are on the rise and will continue along that trend for some time to come. 

Proper classification of workers as independent contractors or employees (and if employees, as temporary, part-time or full-time and as exempt or non-exempt) can mean the difference between financial survival or failure, particularly for a small business, and small business owners, who do not have their own HR staff, are often the least equipped to make these determinations.  Failure to properly classify employees can leave a small business vulnerable to claims for legally mandated employee benefits such as workers’ compensation and unemployment benefits, for discretionary benefits such as health insurance and paid time off, and for back overtime pay.  Properly classifying employees is particularly difficult for small businesses with fluctuating staffing needs, since it is easy for a busy small business owner to forget to reclassify a temporary employee who becomes permanent, or a part-time employee who becomes full-time.   

The solution?  Well, my instinct as a lawyer is this – put it in writing, and keep it in writing.  Even temporary workers could be given something in writing that makes it clear that their status is temporary, with an approximate time limit.  Then calendar the end of that time limit, as a reminder to revisit the issue of how that worker should continue to be classified.  And even small businesses should have a written personnel policy to point to when your employee classifications (or other employment practices) are questioned.       

More dangerous than a misclassification of an employee is the improper classification of a worker as an independent contractor.  Such a misclassification leaves the employer vulnerable to back payroll taxes and penalties as well, which can be substantial enough to put you out of business.  And, whether a worker should be classified as an independent contractor or as an employee can be a particularly tricky determination for a small business owner to make, since the criteria for independent contractor status used by the IRS, the federal Department of Labor and state labor departments don’t all impose exactly the same standards. and are not “exact” but, rather, are open to some interpretation.  Even large companies, such as Microsoft and Federal Express, have been the subject of expensive enforcement actions alleging misclassification of workers.  The new targets for such actions appear to be small businesses, and I’m sure that has alot to do with the fact that they are the most likely to be mistakenly misclassifying their staff.    

The solution?  Again, my instinct is to put it in writing.  As far as I am concerned, a written contract is absolutely essential.  Even with a written contract, however, treating the independent contractor as an employee may indeed make the contractor an employee, whether that’s what you intended or not.  For an explanation of how the IRS analyzes these issues, see IRS Publication 15A.   

Finally, years ago one of my community association clients learned the hard way that even with no employees it still needed workers compensation insurance.  That is because California’s Labor Code provides that one who hires a worker to perform work requiring a license is that worker’s employer if it turns out that the worker doesn’t have the required license.  (It may shock you to hear that sometimes unlicensed contractors lie about their unlicensed status and either provide a fraudulent contractor’s license number or “borrow” another contractor’s license number.)  The association hired an unlicensed contractor, one of the contractor’s employees was injured, and the association was on the hook, with no workers compensation insurance and with a workers compensation exclusion in its commercial general liability insurance policy.  To get a better feel for how California’s Workers’ Compensation Appeals Board analyzes the issue of employment status, take a look here

The solution to this problem?  Legal liability risk management, plain and simple.  A good insurance broker and an attorney to prepare the association’s own contracts, requiring contractors to maintain appropriate licenses and insurance coverage, would have been a big help.

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What to Do if You’re Sued? I Couldn’t Have Said it Better Myself . . .

. . . so I won’t.  Instead, I’ll direct you to this blog post, So Your Business Has Been Sued:  Now What?  It provides an excellent general overview of the steps to take should your business be sued, to which I would like to add the following.

First, while a lawsuit may sometimes take a business owner completely by surprise, there are often plenty of warning signs that a lawsuit may be on its way.  A demand letter from a vendor, subcontractor, customer or client, for example, may include the threat of litigation should an issue not be resolved.  As explained in the referenced blog post, it is important to notify your insurer(s) when you are served with a lawsuit, but it may also be important to notify an insurer of threatened legal action even before you are served.  This is particularly true if the insurance policy in question provides coverage on a claims made basis (such as an errors and omissions policy).  Engage counsel early to advise not only when to notify your insurers, but how.  On this point, I must say that I disagree with the cited blog post’s advice that you should be relying on your insurance broker to determine whether there may be insurance coverage, and to handle notifying your insurer(s) of the lawsuit.  Your attorney should be making the coverage analysis.  And, regarding the “how” of tendering a claim or suit to an insurer for defense, sending it to your broker may not constitute notification to the insurer (unless your broker is the insurer’s agent – and agents and brokers are not the same thing), and may not satisfy your insurance policy’s notice provisions and requirements.

Something the cited blog post doesn’t mention is what you can expect your insurer’s response to be.  Upon notifying an insurer of a claim made or lawsuit filed against you, you will at some point receive a letter from your insurer explaining the coverage your insurance policy may provide for your defense, and any qualifications or limitations there may be on that coverage.  Attorneys call this a reservation of rights letter, although the insurance company will most likely not put that at the top of the letter.  Instead, you will receive a relatively lengthy letter from an in-house claims representative or coverage attorney, or from your insurer’s outside legal counsel (in other words, a letter on legal letterhead).  Receipt of such a letter is a “heads up” to you that the insurer is contesting coverage.  Don’t ignore a reservation of rights letter, because it is a genuine “red flag”.  Instead, consult an attorney with knowledge about insurance coverage, to determine if there are grounds to disagree with the position your insurer has taken, and to decide what steps should be taken if there are grounds for disagreement.  This is important, for several reasons.  First, while generally the insurer has the right to pick your defense attorney, control the defense, and determine whether to settle the case and if so for how much, the insurer’s reservation of rights may give you important rights to select your own defense counsel and control your defense (attorneys in California refer to this as Cumis rights).

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The “Why and How” of Risk Management

IRMI (the International Risk Management Institute, Inc.) recently published an excellent “white paper” covering the basic principals of business risk management.  You can find it here.  It is somewhat lengthy (approximately 70 pages), but well worth the read. 

Described as an “illustrative introduction to risk management for business executives”, the author (George L. Head, Ph.D., CPCU, ARM, CSP, CLU) begins by asking the reader to consider a hypothetical scenario (a fire causing the near collapse, and ultimate demolition, of a 2-story concrete garage supporting a 5-story, 80-unit apartment complex).  This factual scenario is then used to provide a “concrete foundation” (pardon the pun) from which the author explains the basic “whys and hows” of risk management for business organizations.  

One of the things I particulary like about the paper is that, in explaining “Why We Manage Risk”, Dr. Head includes “Preparing for Opportunities”, and puts it right up there near the top of the list (second only to “Safeguarding Resources”).  The positive aspect of business risk (the fact that business risk is necessary to the creation of business opportunities) is rarely mentioned, much less highlighted, in discussions of business risk management.  My most successful clients understand this key point and are careful to put themselves in the best position possible to take advantage of business opportunities by effectively managing the risks inherent in those opportunities, through appropriate insurance coverage and contractual risk transfer (the basics of which are also discussed in this paper).

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The Importance of Knowing That You Don’t

map and compassFurther to my last post (here), regarding the complexity of commercial insurance policies, I was thinking that a concrete example or two may be the best way to illustrate my point.  (The point being that it’s important to know that you don’t know, and to consult a trusted advisor who does.)

Recently, I have been asked to analyze the coverage provided by “group” commercial insurance policies.  As such policies raise a number of issues which even sophisticated commercial insurance “consumers” can miss, I thought they would make good, concrete, examples of how a skilled consultant can help you navigate the complexity in a way that serves your best interests. 

By “group” commercial insurance coverage, I am referring to an insurance policy or package of policies intended to protect multiple, separate, unrelated insureds, all under one policy.  Over the past dozen years or so I have seen such policies referred to as group, blanket, master, pooled, or consolidated policies (and am sure they go under other labels I’ve not seen yet).  What they are called doesn’t matter much; what they cover and how they do it does, and it can take some expertise to figure that out. 

Before I go any further, let me be very clear that I do not sell insurance.  I have no financial stake in whether a client opts to obtain insurance coverage via an individual policy or as part of a group.  Others involved in the transaction do have a financial stake.  The client’s current broker stands to lose money, and the broker selling the group coverage stands to make money.  My job is to make sure that my client has the information necessary to make an informed decision.  Here’s how that works. 

Example #1:  A geotechnical engineer considering purchasing his professional liability insurance coverage (often referred to as “errors and omissions” or “E&O” coverage) through a group policy offered by a professional trade organization.  The advantage of the group policy is obvious – a substantial reduction in premiums.  The disadvantages are not as obvious.  That’s where I come in. 

Some of the coverage issues I identified were:

1.  Unlike his own separate policy, under which he is the named insured/policyholder, the trade organization is the named insured/policyholder (what we insurance geeks refer to as the “first named insured”) under the group policy.  While he would be listed on a schedule of parties covered by the policy, and would have his own coverage limits (which would actually be higher than what he had under his own separate policy), there were some rights he would give up under the group policy as a result.  For example, he would not have the same right to receive notice of policy changes, nor would he have any ability to negotiate changes to the policy to meet his particular needs.  If the trade organization negotiated or agreed to a change in the policy which he didn’t like, Mr. Engineer would be stuck with it unless and until he could replace the policy with one of his own again. 

2.  His coverage would be contingent upon remaining a member of the trade organization.  If he left the organization and had to go back to purchasing his own separate insurance policy, would he be able to buy “tail” coverage under the group policy to cover claims based on allegedly wrongful acts occurring during the time he was covered by the group policy but not made until after he left the group policy?  If not, he might be stuck with a gap in coverage in the future.    

3.  As with most professional liability insurance, both policies (the one he already had and the group policy he was considering switching to) were “claims made” policies.  The group policy would only provide coverage for claims which are both made and reported during the same policy period.  His separate policy provides coverage for claims made during the current policy period based upon alleged wrongful acts which occurred prior to the current policy period (back to the original inception date of his first policy, nine years prior).  It appears from the proposal for the group policy, however, that claims made during that policy’s effective period based upon prior acts would not be covered.  This would need to be clarified in order for an informed decision to be made. 

4.  While he would have his own separately stated coverage limits under the group policy, I pointed out to Mr. Engineer that the aggregate policy limits (the total amount of coverage the policy would provide to the group in its entirety) might be the more important number.  Although the group policy appeared to have a ginormous (that’s a technical legal term) aggregate limit (hundreds of millions of dollars), that number was meaningless in a vacuum.  Mr. Engineer can only know what the aggregate policy limit really means if he knows how many others are covered by the group policy, what their potential risk exposure is, and what their loss history has been.   

5.  The policy Mr. Engineer has now covers liability arising from “wrongful acts” committed in the course of providing “professional services”, and defines both terms very broadly.  He has always been confident, therefore, that none of his work falls outside the scope of the policy’s coverage.  I pointed out that unless the broker for the group policy is willing to provide him with a copy of that policy’s coverage language, he cannot have the same confidence about the scope of coverage provided by that policy.  Similarly, without a copy of the policy he cannot know what coverage exclusions there are.  Without that information, an apples-to-apples comparison of the coverage provided by both policies could not be made.  

(As an aside, I must say that in my experience it is particularly difficult to obtain exemplar coverage parts for group policies; in fact, under many such policies the scheduled insureds never receive a copy of the policy at all.) 

Example #2:  A community association (condominium homeowners association) considering purchasing all of its insurance coverage (including property, general liability and directors and officers liability coverage) through a group policy.  The board of directors wanted to know whether the group policy would in fact give the association “the same or better” coverage than it currently has under its individual policies.  Given that the premiums under the group policy would be substantially less than the premiums the association currently pays, one of the board members was concerned that the group policy might be “too good to be true”, and convinced the other board members that in order to fulfill their fiduciary duty to the association and its members they should consult a coverage attorney.  (That would be me.)

Some of the coverage issues I identified were:

1.  The first named insured on the group policy is the association’s property management company, and the group is comprised of associations under contract with that management company.  As with the group policy Mr. Engineer was considering, the association would be listed (along with the other associations in the group) on a schedule of parties covered by the policy, and would have its own coverage limits, but would not be the named insured.  So, as with the group policy Mr. Engineer was considering, the association would lose some of the rights it had under its own individual insurance policies, such as the right to receive notice of policy changes and the ability to negotiate coverage changes. 

2.  In considering whether to switch from its own insurance policies to the group policy maintained by the management company, the association’s board of directors would need to consider whether the group policy would satisfy the insurance requirements in the association’s Declaration of Covenants, Conditions and Restrictions (the “CC&Rs”).  Among them were the requirement that the association’s policies be issued to the association as the named insured, and that the association (as the first named insured) be the insurance trustee for each owner and mortgagee.  I pointed out that a strong argument could be made that the group policy would not satisfy these CC&R requirements.   

3.  In addition, the CC&Rs require the association to maintain its insurance coverage in compliance with the requirements of FHLMC, FNMA, GNMA and FHA (the federal mortgage guarantee agencies).  Given the fact that the agencies’ response to plummeting real estate values and soaring mortgage foreclosure rates has been to tighten their lending guidelines, I recommended that the board ask the association’s general counsel to provide an opinion letter regarding the proposed group policy’s compliance with those guidelines.  If such an opinion letter could not be obtained, it was my recommendation that the CC&Rs would need to be amended.  (As an aside, on December 16, 2008, FNMA issued an announcement clarifying its guidelines regarding “master” or “blanket” hazard insurance policies, indicating that “a blanket policy that covers multiple unaffiliated condominium associations or projects” is not permitted.  I am not aware that  FNMA has ever determined that multiple associations covered by a group policy are “affiliated” by virtue of the fact that they all use the same management company.)   

4.  With respect to points 2 and 3,   I pointed out that the group policy’s directors and officers (“D&O”) liability coverage, like the association’s current D&O policy, would most likely exclude coverage for liability arising from failure to maintain required insurance coverage.  This would put the board members at personal financial risk should they agree to insurance coverage for the association which does not comply with the association’s own governing documents.       

5.  The association’s coverage would be contingent upon remaining a client of the named insured (the management company).  The association would, therefore, face the same potential gaps in coverage as Mr. Engineer would should the board of directors ever decide to change management companies. 

6.  As with Mr. Engineer, I recommended that the board of directors obtain information about the other associations in the group necessary to evaluate the group policy’s aggregate coverage limits.   Since unlike the group policy proposed to Mr. Engineer the group policy proposed to the association included property as well as liability insurance coverage, I explained that in order to determine the sufficiency of the aggregate limits for the property insurance coverage it would also be important to determine how many properties share the property insurance aggregate limit, the replacement cost for all of those properties in the aggregate, and where they are located geographically (since if they are in close proximity to each other there is a greater risk that they may all be subject to the same catastrophe, such as an earthquake or flood).   

7.  Finally, as with Mr. Engineer, I advised the board of directors that without a copy of the group policy’s coverage parts, exclusions and endorsements, they could not make an apples-to-apples comparison.

(As an aside, I should note that there are a number of issues pertaining to the above which, had I been asked, I would have recommended the management company obtain its own legal counsel to resolve.  Obviously, as named insured the management company would be benefitted by the group policy, but it would also assume some additional responsibilities, accompanied by legal risk, as well.)

The Bottom Line:  A substantial reduction in insurance premiums can be a powerful motivation to change your commercial insurance coverage.  Keep in mind, however, that clichéd expressions such as “you get what you pay for” and “too good to be true” have a basis in truth.  The bottom line is that while the prospect of lower premiums may be the motivation to explore other insurance options, lower premiums should only be a deciding factor after you have first made an apples-to-apples comparison of your commercial insurance options.  Don’t know if you’ve been presented with an apples-to-apples comparison?  Consult a coverage expert.  In the long run, it costs a whole lot less than continuing not to know.

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