Claims-Made Trap; ISO Filing New Designated Premises Endorsement—Watch Out; FEMA Buying $1 Billion Flood Reinsurance; DFS Rules Against Troublesome Crime Exclusion; Lower A.M. Best Rating Linked to Increased Risk of Impairment

Claims-Made Trap

Claims-made policies are different animals and they can viciously bite the unwary. An example: a Pittsburgh University claim under a Lexington Insurance Company policy. This claim arose out of a professional liability dispute between University of Pittsburgh and Ballinger and Company, the architects on a building renovation of Salk Hall at the University. Ballinger carried professional liability with Lexington. On the last day of the Lexington policy’s coverage period, January 31, 2012, Ballinger (probably through its broker) submitted an ACORD notice of claim to Lexington describing the occurrence as “Senior management has been advised by University of Pittsburgh that this project (work on Salk Hall at the University) is experiencing problems and delays in its early stages.” The date of the occurrence was listed as January 31, 2012.[i] Trouble ensued.

Claims-made policies often spell out in great detail the claim information the insured is required to provide. The Lexington policy called for the claim notice to set out:

1. The actual or alleged Breach of Professional Duty or circumstance which is the subject of a potential Claim;
2. A description of the Professional services rendered by the Insured which may result in the Claim;
3. The date(s) of such conduct which may result in the Claim;
4. A description of the injury or damage that has or may result in a Claim;
5. The identities and address of any potential claimant(s);
6. The anticipated location(s) of any such potential Claim;
7. The circumstances by which the Insured first became aware of the potential Claim.

The court neatly summarized the difference between claims made and occurrence based policies:

“Under Pennsylvania law, ‘failure to comply with the reporting provision of a claims-made policy’ precludes coverage. Although a harsh consequence, claims-made policies, and their reporting provisions, are enforceable. (citations omitted). In contrast, notice provisions in occurrence-based insurance policies ‘do not define coverage and should be liberally and practically construed.’ In the claims-made context, when the insured has breached the notice requirement, an insurer need not show prejudice to deny coverage.”

Lexington asked Ballinger to provide additional information, but didn’t receive any. On March 5, 2012, Lexington declined coverage. It identified four items that were missing from the report submitted by Ballinger:

• the actual or alleged Breach of Professional Duty or circumstances which is the subject of a potential Claim;
• a description of the Professional Services rendered which may result in the Claim;
• the date(s) of such conduct which may result in the Claim; and
• a description of the injury or damage that has or may result in a Claim.

Lexington advised Ballinger that the notice was inadequate and that any claim arising from it “will not be deemed to have been made during the policy period.”

The court held that the notice provided on January 31, 2012 was clearly insufficient and therefore no claim payment was called for on the Lexington policy.

Pittsburgh[ii] then argued that if the notice did not trigger the Lexington policy, Ballinger’s renewal policy with Axis must provide coverage. The court disposed of that argument, pointing out that neither policy provided coverage.

Practice Point: Be careful when reporting any claim. Be super-careful when reporting a claims-made claim.

ISO is Filing a New Designated Premises Endorsement—Watch Out

The designated premises endorsement is close to the top of my Don’t-Want list. It narrows coverage unreasonably. Nevertheless courts sometimes apply it in the insured’s favor. I’ve written about those cases[iii] and speculated that ISO would close the gap. Now ISO has, with a resounding slam.

You may think designated premises endorsements are used only on policies placed by producers who aren’t paying attention and that you can get them eliminated in your clients’ policies. Think again. They’ve become endemic in Risk Purchasing Group policies and your chances of getting changes in an RPG policy are between nil and zero.

The solution to the problem of unintended coverage could have been cleared up by better wording in the application. Instead, ISO has filed a draconian new endorsement slated to be available later this year. The new form is entitled: Limitation Of Coverage To Designated Premises, Project Or Operation, (CG 21 44 04 17). Only the edition date (the last four digits) is changed in the form number and the only change in the title is the addition of the word “operation.” Seemingly small changes, but there’s a world of difference between the new form and the older ones.

For starters, the previous endorsements ran just five lines of operative language; the new one runs three pages! Instead of just limiting coverage to the ownership, maintenance or use of the scheduled premises or the scheduled project as the case may be, the new form totally replaces the wording of a key section of the Coverage A  definition.

The new definition limits coverage to occurrences on the premises shown in the schedule. It does not add the words “and operations necessary or incidental to those premises.” Instead it limits coverage to only the operations shown in the policy schedule. That can be a huge difference. For example, if the operations are described as “retail store,” is there coverage for wholesale operations if the claim occurs away from the premises? Insurers may say no. An insured might argue that it’s ambiguous, but to win an argument in court is both risky and expensive. Furthermore the description of operations can be vague or out-of-date, generating a blizzard of additional disputes.

Just as insureds’ attorneys found coverage for claims never intended by the “necessary or incidental” wording insurers formerly used, insurers may interpret the new wording as excluding claims in ways that insureds never expected.

FEMA Buying $1 Billion Flood Reinsurance

FEMA dipped its toe into the reinsurance market for National Flood coverage last year with the purchase of $2 million of flood reinsurance. This year, it got serious with a $1 billion purchase.[iv] Nevertheless, the qualms about the coverage that I listed in my previous column remain: I just don’t see the value to the Federal government in buying reinsurance. As a fellow insurance maven remarked, “What’s next, reinsurance of the Federal TRIA exposure?”

NY DFS Rules Out Troublesome Crime Exclusion

A key executive at one of your insureds discovers that a top salesperson has been padding his expense account. The executive is convinced that it won’t happen again because she believes the employee is truly repentant and because the firm’s accounting system has been improved to catch such discrepancies. Two years later she finds that while his petty cash accounts are clean, he’s supplementing his income by collecting cash for past due accounts from customers and pocketing the funds. When you submit the claim, it’s declined. Why? Crime insurance coverage for embezzlement and other employee dishonesty excludes theft by any employee known to have committed a theft or other dishonest act. Here’s typical policy wording:

Termination As To Any Employee

This Insuring Agreement terminates as to any “employee”:

(1) As soon as:

            (a) You; or

(b) Any of your partners, members, managers, officers, directors, or trustees not in collusion with the employee; learn of theft or any other dishonest act committed by the employee  whether before or after becoming employed by you.

Now, New York is ruling against this exclusion in certain instances because it makes those with criminal records virtually unemployable no matter how spotless their subsequent behavior. I can understand New York’s position, but I have an additional objection to the provision terminating coverage for a dishonest employee: insureds don’t know about this exclusion and it’s easy for them to be tripped up.

The Department of Financial Services (DFS) regulation will alleviate a part of the problem. Under the new regulation the exclusion can remain, but it can’t be applied to an employee convicted of criminal offenses in any jurisdiction prior to being employed by the employer if, after learning about an employee’s past conviction, the employer made a determination to hire or retain the employee based on factors set out in NY Correction Law.[v] Violating the regulation is designated as an unfair method of competition and an unfair or deceptive act and practice in violation of DFS rules. It will apply to New York policies issued, renewed or delivered after July 1, 2017.

It will not be a violation of DFS rules to void coverage where there is no criminal conviction. Thus, the denial of coverage to the employer who continued to employ an employee who padded an expense account would not be a violation if the employee has not been convicted.

ISO is working on an endorsement to the crime policy to deal with this regulation. Other insurers may elect not to amend the policy at all; in that case, the insurer could comply with the regulation by not denying coverage in the circumstances set out in the law even though the policy permits it.

I’ll keep you posted on the ISO endorsement when it’s published.

A.M. Best Study Confirms Insurers with Lower Ratings More Likely to Become Impaired

The go-to source for financial ratings of insurers is A.M. Best. Knowledgeable insureds check the ratings of their insurers. A range of acceptable A.M. Best ratings is usually specified by mortgagee and those requesting certificates of insurance, etc. The question is whether choosing insurers with higher A.M. Best Financial Strength ratings decreases the chance that the selected insurer will become financially impaired.

A.M. Best has just published its latest study of the financial impairment frequency for insurance companies. It covers the 38 years from December 31, 1977 thru December 31, 2015.[vi] It shows that not only is there a significant difference in eventual financial impairment rates for firms with the highest Financial Strength ratings versus those with the lowest, but that the percentage of companies that are eventually impaired increases steadily as the rating decreases. The study clearly indicates that insurers with better ratings at inception are much less likely to become financially impaired.

A.M. Best takes a conservative approach to evaluating insurer financial strength. It designates an insurer as a Financially Impaired Company as soon as the first official regulatory action is taken by an insurance department. Such state actions include regulatory procedures such as supervision, rehabilitation, receivership, conservatorship, a cease-and-desist order, suspension, license revocation, administrative order, as well as involuntary liquidation because of insolvency. Even though not all financially impaired companies go into liquidation or become insolvent, A.M. Best feels it is best to take a cautious approach.

I’ve selected some representative values to illustrate the point that a lower rating portends a higher risk of financial impairment; the full report shows that the trend exists over the entire range:

A.M. Best has provided strong evidence that their rating system identifies companies with superior financial prospects.

It also confirms the wisdom of the consensus that long-range exposures be placed with insurers with higher A.M. Best ratings. For example, umbrella liability coverage should be placed with companies with high ratings because umbrella claims can remain open for years and years. On the other hand, for property insurance coverage you might use a shorter horizon because almost all property claims are settled within two years and virtually none are still pending after five years, unless they are in suit.

Another factor to consider in evaluating Best ratings is the distribution of ratings. As of the end of 2015, here are the percentages of companies receiving particular ratings:

(Percentages add up to 101% due to rounding)

Almost three-quarters of the companies had ratings of A- or better; almost 90% had ratings of B+ or better. Requiring a B+ or even A- rating doesn’t eliminate most insurers.

Ratings of A- or B+ are often the cut-off points used by many brokers, consultants, mortgagees, additional insureds, etc. There are exceptions. I recently reviewed specs for a school construction project that required insurers that have at least an A rating and I’ve come across mortgagees that demand A++ ratings, which is definitely overkill.

Put your clients on notice when the proposed insurer has a rating below A-. It’s a way to avoid headaches and E&O claims.

____________________

[i]    The University of Pittsburgh v Lexington Insurance Company and Axis Insurance Company, US District Court, SD NY13-cv-335 (KBF) 7/21/16

[ii]    The University of Pittsburgh was given permission by the court to be substituted as plaintiff.

[iii]   For example see: “Designated Premises Exclusion” Insurance Advocate June 15, 2015

[iv]    Many years ago, Senator Everett Dirksen is reputed to have said “A billion here, a billion there and pretty soon you’re talking about real money. That, of course, before the Federal budget was measured it trillions—it’s now over three trillion.

[v]    NY Correction Law sets out nine broad factors to be considered. See: https://www.omh.ny.gov/omhweb/fingerprint/article23_a.htm

[vi]   A.M. Best Special Report: Best’s Impairment Rate and Rating Transition Study – 1977 to 2015 http://www.ambest.com/nrsro/FormNRSRO_Ex1_RatingsImpairment.pdf