Further 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.