Claims, claims everywhere…

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I’ve seen a steady and disturbing uptick in claims over the last 18 months.  Less disturbing to me personally due to  not having a pen right now, but a bit disturbing for the industry, and I am disturbed by proxy on behalf of all my underwriter-friends.

I can’t help but think that the economy is largely responsible for these increased claims, but other than insureds going bankrupt and incurring D&O claims due to such bankruptcy, or EPL claims when laying off a substantial number of employees,  the connection may not be all that apparent.

I put on my noodling hat the other night and came up with the following thoughts, mostly pertaining to E&O:

How is the economy causing claims for our insureds?

Financial pressures, cost-cutting measures and layoffs can cause disruption in previously well-managed processes.  I can’t tell you how many times I’ve seen a reduction in staff where all the work just gets parsed out to the remaining employees.  Many of those employees have never done that work before, they don’t receive proper training, and the work is piled on top of an already-full desk with no incentive to put on the afterburners other than fear that their job is next if they don’t make themselves indispensible.    Is this conducive to quality output?  I think not.

For most businesses, the downturn in revenue occurs before the fall-off in demand, so it’s almost impossible to service an account throughout its lifecycle if payment is loaded up front and recognized immediately.  When I was on the retail side, one of our accountants asked why we didn’t earn our revenue over the 12 month policy period, versus recognizing it when bound.  The insurance folk guffawed at the accountant – “Why, that’s never done!” they said.  True, but why not?  Because policies rarely cancel mid-term?  Not so in many lines.  Because the work attendant upon that piece of business is completed at the time the account is invoiced?  Also not the case.  Because we assume nothing will ever go wrong, and we plan for constant growth?  Yeah, that’s the ticket.

The folly of this optimistic belief system hit me hard when one of my prior employers lost an underwriting program due to the carrier going into receivership.  Revenue ground to a complete halt in one month, but we had to service hundreds of policies for the remainder of the policy year.  We went from seven or eight people working on that program to one person pulling loss runs and trying to manage the endorsements and another trying to re-market and salvage what we could.  It was not a pretty picture on many levels, but it was particularly painful because it could easily have been avoided.  What if we had recognized the income on that program as it was earned and staffed accordingly?    We would have had a slow, predictable step-down in revenue corresponding with the step-down in servicing demands.

All that being attractive from a stress and humanitarian perspective, the E&O-related question here is – what is the likelihood that errors were made during that run-off period with the staffing stresses that existed, versus if we had taken a more conservative approach to recognizing our income and kept a more suitable staffing level throughout run-off?

It also occurs to me that while our insureds may be suffering from financial stresses that could lead to claims, at least we can ferret that out by looking at financials and asking for information if any red flags are raised.  But what about the financial condition of their clients?  If your insured is providing services of an advisory nature, or services that roll up into a larger deliverable for the client’s customers, you can bet your bottom dollar that if something goes wrong, the client will be looking under every stone for someone to blame so he can recover money for the loss.  Either he’s trying to avoid being sued, or he already has been and figures he’s not going down alone. 

Back in the day, circa 2005 and earlier, if there was any kind of relationship between your insured and his client, a mistake that damaged the client in some way would not necessarily result in a claim.  A lot of times the insured could make it good.  If not, the relationship tempered a client’s desire to make a claim against the insured.  But now…The insured doesn’t have the resources to fix a problem, and the client doesn’t have the resources to absorb the problem or honor the relationship and work through the issues.  It’s all about keeping your head above water, and a kinder, gentler response to a perceived wrong is not long considered, if at all.

How can you tell if the insured’s clients are under financial strain?  You can sort of assume that they are these days, but clearly that is not helpful, unless you choose to stop insuring anyone at all until the economy turns around.   It used to be that E&O apps asked the insured if he ran a credit check and/or background check on prospective clients.  This was to ferret out payment/credit problems and any history of litigation.  I haven’t seen that question in a long time (except maybe on an LPL or APL app), but agents and their insureds would do well to resurrect that process.

And of course, a client’s financial stress will cause them to cut corners and have more errors in their own services – but they will still try to pin the causation on someone else so they can get reimbursed for their troubles.

Where does this leave us?  In a fine pickle.

We find ourselves with cost-cutting/cost-saving measures, requirements to be ever more productive with less staff and fewer resources, cutting corners on best practices because we’re doing the work of 2, 3, or 4 people.  We have unmotivated staff, untrained support people (or producers/underwriters), and are looking over our shoulders wondering what’s coming after us next, and how bad it is really going to get.

Our clients are in exactly the same place, unless they’re a debt collection company or something similar, with a contrarian prime time for maximum profitability.  Our clients’ customers have the same problems and are looking for the best value and scrutinizing everything they pay for.   If one cut corner or under-staffed error in the insurance program intersects with one mistake made by the client – you’ve got an uncovered claim with a very high likelihood that it will roll uphill to become your E&O problem.

What can we do to address these issues?

As agents, we can and should take a closer look at who we bring on as clients.  I know it’s hard to second guess a potential account at any time, let alone when you’re scraping and clawing for every penny of revenue.  But failing to vet your potential clients can result in unpaid accounts receivable, an overabundance of servicing issues, an insured that doesn’t have time to provide sufficient and accurate information regarding their exposures, and in the end anything that goes wrong will be your fault and your commission income has been frittered down the drain with the handling costs of that account.

How can you evaluate potential clients?  It’s probably wise and reasonable to run a credit check, and research any Better Business Bureau  or similar complaints.  Knowing the potential client through the community or associations is always a good way to gather background information.  Requesting a copy of financials can be helpful, if the insured is willing to share them, and if the type of insurance you’re placing generally requires the financials.  The downside to the financials is that they are always  retrospective, and you are most likely to get ’09 year-end financials this early in the 2011 year.  A lot could have changed.  I’d say year-end financials and the most current interims would provide an adequate picture.

It may also be prudent to execute a contract with your client that defines the rights, duties and obligations of each party.  The insured must provide thorough and accurate answers to all questions in the information-gathering process, must notify you of any changes, and must pay premiums.  You would offer whatever services detail your level of engagement.  My philosophy here is that if the insured goes off the rails and doesn’t inform you of what’s going on, you can trot that contract out to reinforce your defense that you only had an obligation to respond to the needs of which you were informed.  If the insured engaged in shenanigans you didn’t know about and therefore didn’t insure or didn’t explain the exclusion applicable thereto, the contract will again bolster your defense.

The fact that we provide so many services for free and without contracts is a constant source of amazement to me, but that’s a topic for another day.

For the underwriters out there, I believe a return to some good old-fashioned questions would be helpful.  Perhaps the creation of an “Economic Conditions Impact Questionnaire” would be suitable.  Over the last many years, questions about financial condition and how the insured relates to its clients have slowly faded away. 

Certainly, one of the growing drivers of claims is a client retaliating against our insured alleging unsatisfactory rendering of services in response to the insured attempting to collect monies owed.  This is a tried and true way to get the wolf to back away from the door, and the less liquid the insured’s client is, the more likely the response will be particularly venomous.

The following questions could help identify an insured that is sliding into a profile of higher potential for claims:

  1. Do you check the litigation history of your potential clients?
  2. What is the average length of your relationship with your clients?
  3. Are clients allowed to pay in arrears for your services?  If yes:
    1. Do you run credit checks on your clients before extending terms?
    2. Does your contract for services document billing rates and payment terms?
    3. What percentage of your accounts are over 90 days past due?
    4. What actions do you take to recover monies for aged receivables?
    5. Do you turn past due accounts over to a collection service?
    6. Have you filed or threatened suit against any clients in the last 24 months in order to collect monies owed to you?
    7. Do you anticipate taking action against any clients in the next 12 months in order to collect monies owed to you?
    8. Does your contract for services include a provision for you to return fees to the client, if the client is dissatisfied with your services?

I believe these questions, and similar ones you might cook up on your own, can be very helpful in identifying incipient problems.

I’ve also noticed in a few policies an exclusion for countersuits brought in response to a suit for fees brought against a client by the insured.  That approach would certainly insulate the carrier from these retaliatory claims by disgruntled (or broke) clients.   I’m not sure that any particular carrier would want to be the first to jump wholly into that pool, and the exclusion might be a deterrent to the purchase of that carrier’s policies, all other things being equal.   However, excluding these countersuits on an action-specific basis could be a brilliant solution.  This is similar to the “seek counsel” warranty exclusions in some older London EPL policies.

To implement this scenario, the carrier would add an endorsement to the policy that binds the insured to conferring with qualified counsel prior to filing a suit for fees.    Such counsel could be a risk management/mitigation person at the carrier, or it could be an approved panel counsel.  If the insured does not confer with qualified counsel there would be no coverage for any countersuit arising from their action against the client.  If the insured does confer with qualified counsel, there would be coverage.   Reasonable, wise, risk-management oriented, and tremendously helpful in getting the insured through the minefield of collecting debts without generating an attack on itself.

 Bottom line, if the microcosm I’m observing does exist in a broader form, we are either experiencing an anomaly that will correct itself soon enough, or we are experiencing the beginning of a new “normal” which is not all that attractive.  Taking a more considered approach to accepting any given insured as a client, both at the agency level, and at the carrier level, could be the cure for many ills.  It’s time to look at more than the insured’s likelihood of a claim arising from their operations, and add the contemplation of the likelihood of a claim or other unpleasantness arising from their financial condition.

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