Ask an agency principal about internal procedures and he or she inevitably will tell you, "Our procedures are proper; you won't find any discrepancies in our operations." Following a third-party audit of those procedures, however, most agency principals are horrified to learn just how many procedural mistakes are being made in their offices every day. These mistakes can lead to E&O claims and substantially impair an agency's ability to defend against claims.
This article reflects Alpine Risk Management Corporation's findings during procedural reviews at more than 150 insurance agencies over the past 5 years. It presents a checklist of procedures that can eliminate breakdowns and substantially reduce an agency's E&O exposure.
1. Have applications signed and dated. More than 70 percent of the agencies reviewed do not require the insured to sign and date applications for commercial insurance. The producers told our analysts they could not return the application to the insured and ask him or her to sign it. Basically what they were saying was, "We sold the policy, now let's get it issued and go on to the next one." From a defense point of view, it is extremely important to have the insured sign and date the application. If the insured has indicated that he or she has read the application by signing and dating it, the agency has a better defense if a claim arises regarding coverage that was not included at policy inception.
2. Peer review applications. A majority of agencies do not have procedures for double-checking an application that was completed by a producer or CSR. Our analysts found many agencies in which the producer completes the application and sends it directly to the company without having it processed by the CSR.
3. Document coverage rejections. A majority of the agencies reviewed do not have evidence in their files when insureds reject offers of higher limits or other coverages. It is extremely important to document when broader coverage, higher limits, or increased values are rejected by having the insured sign and date an acknowledgement of the offering. Without this documentation, insureds frequently develop amnesia on the witness stand following an uninsured or underinsured loss.
4. Document UM and UIM coverage decisions. Uninsured motorists (UM) and underinsured motorists (UIM) limits usually are lower than auto liability limits. Most agencies keep no evidence that insureds have rejected higher limits. Also, some companies would not write higher limits, but there is usually no documentation that the insured has been so advised and has accepted the lower limits.
5. Document the source of property values. On many occasions our analysts found that the agencies have accepted the insured's estimates for values on buildings or contents. Ninety-five percent of the agencies studied fail to note in the insured's file when the insured establishes the property values to be insured.
6. Inspect insured properties. More than 75 percent of the agencies reviewed have no established procedures for personally inspecting the property risks they insure. In fact, these agents told our analysts that they had never personally seen the properties.
7. Establish umbrella claims reporting procedures. In many agencies, there are no established procedures for notifying excess or umbrella insurers when a bodily injury claim is reported under the primary coverage. Even small BI claims can balloon beyond policy limits, and late-reporting claim denials are very possible when the umbrella or excess insurer has not been notified. For example, one of our analysts was involved as an expert witness in a case where the excess insurer was not notified and the primary insurer refused an offer to settle within the primary policy limits. The case went to trial and the award was for $345,000 above the primary limits. The excess insurer sued the agent for breach of contract.
8. Establish defined procedures for placing business through a surplus lines broker. Eighty percent of the agencies we reviewed do not have any standardized written or automated procedures for qualifying or placing business through a surplus lines broker. Also, the majority do not determine whether the surplus lines broker carries E&O insurance in limits at least equal to its own E&O limits. Furthermore, the overwhelming majority of the agencies had neither thoroughly examined nor analyzed the written contracts they had signed with surplus lines brokers. As a result, the agencies were unaware of hold harmless clauses and other restrictive wording in contracts.
9. Establish an internal quality control program. Eighty-five percent of the agencies reviewed do not have any type of a standardized internal quality control program. They have no internal audit procedures to make certain that all personnel were following established agency procedures. This is extremely important, especially when agencies are adding staff. Too often a new CSR will bring his or her own favorite way of doing something from a previous job. Soon, everyone is doing his or her own thing, and standardization and procedural consistency goes out the window.
10. Review company financial ratings and notify insureds of changes. Eighty-five percent of agencies reviewed have no established procedures for regularly monitoring the financial ratings of the companies with whom they place business. Most agencies also do not have a standard procedure for notifying their insureds of changes in their insurers' ratings. A strong argument can be made that agents have a duty to notify their insureds when their insurers' ratings are lowered.
11. Execute contracts with independent contractors. Many agencies classify producers as independent contractors rather than employees. However, there often is no written contract between the agency and these producers, and when there is a written contract the arrangement probably would not withstand a close inspection by the IRS without a clear explanation of the producer's duties. In other words, the existing arrangements often do not comply with the generally accepted common law factors of independent contractors as confirmed by the U.S. Supreme Court in Nationwide Insurance v Darden or the IRS 20 Rule test for establishing employment relationship.
12. Include a "procedural observance" clause in the contract. The contract you use with producers you consider to be independent contractors should contain a paragraph covering "procedural observance" requiring the independent contractors to follow the agency's procedures. The majority of audited agencies have at least some producers who do not follow established agency procedures. These "loose cannons" substantially increase E&O risks.
13. Establish agency automation procedures. Ninety-five percent of the agencies that are fully automated have no written procedures to assure compliance with federal and state laws regarding the admissibility of their automated data and no standard procedures to audit the accuracy of the data entered into their systems.
14. Eliminate needless duplication. During recent internal reviews of agencies that were on transactional filing, CSRs told analysts that some producers do not like or accept the procedure of transactional filing and require the CSRs to photocopy everything they place into the T-file so the producers could keep it in their own files as well. This practice can lead to problems beyond the obvious waste of time. For example, these producers may file information in their own files that does not get into the T-file. In the event of an E&O claim, where all information concerning the insured is subpoenaed as evidence, the plaintiff's case is immediately strengthened if there is a discrepancy between the two files.
15. Execute brokering contracts. Our analysts found that many of the agencies reviewed place business for other agents and that virtually none of them had written contracts with the other agents. As a result, the placing agent has no evidence of the originating agent's errors and omissions policy, nor is there a hold harmless agreement between them to protect the placing agent against an error by the originating agent.
16. Document cellular phone conversations. While most agencies have a procedure for recording phone messages in the office, more than 90 percent have no procedures for keeping records on cellular phone conversations.
17. Develop E&O claims reporting guidelines. The majority of agencies reviewed have no defined written or automated procedures for reporting a claim to their E&O insurers, and most do not have established procedures for follow-up on the status of the incident or claim if it is reported.
18. Provide access to company binding authorities. Among those agencies that have automated systems, more than 90 percent do not have their companies' binding authorities entered into the system for all personnel to access before binding a risk.
19. Retain fax transmission verifications. An overwhelming majority of the agencies neither attach fax transmission verification sheets to original documents nor maintain records of fax transmissions.
20. Secure claims drafts. In the majority of agencies that have claims draft authority, the unused claims drafts are stored in unlocked desk drawers.
21. Promote good interoffice communication. In many of the larger agencies, there is a complete lack of communication among departments. In one particular agency, our analyst found that producers in different units actually compete against each other with different insurers on the same accounts, and CSRs in many smaller agencies voiced similar complaints.
22. Standardize your agent/broker of record letter. Many agencies do not have a standardized agent/broker of record letter, and CSRs are drafting their own. The majority of these letters do not contain a clause wherein the insured holds the new agent of record harmless for any errors or omissions on the part of the former agent/broker. Such a provision can prevent major E&O headaches.
23. Establish a confidentiality policy. More than 90 percent of the agencies reviewed have no established procedure or policy concerning the confidentiality of a customer's file. In many agencies, for example, someone calling to claim they or their client had been involved in an accident with the agent's insured would be provided with the insured's policy information. This is a disclosure of privileged information! Under no circumstances should any information be given to another party without the prior express written permission from the insured.
24. Teach producers about new product offerings. Failure to teach producers about new types of coverage results in both lost sales opportunities and E&O claims. For example, with the exponential increase in claims against employers, agents should be aggressively marketing employment practices liability insurance (EPLI) to all commercial insureds. However, our analysts found that more than 85 percent of the agents interviewed are not selling EPLI or offering it to their commercial insureds. Their explanation for this omission: "We don't sell it because we don't know anything about the coverage."
25. Don't "baby-sit." Many agents will call their direct-bill insureds following receipt of a notice to cancel for nonpayment and remind them to pay the premium before the cancellation takes effect. This practice, referred to as "baby-sitting," is acceptable if you follow up with all insureds who receive a cancellation notice. This is an expensive practice, and it presents a potential E&O problem if the agency misses calling a customer and there is an uninsured loss. By adopting this practice, the agency develops a "special relationship" with the insured and can be held to a higher standard of care by the courts. To safely cease this practice once it is established, notify all insureds that you will no longer be following up on cancellation notices for nonpayment of premium.
26. Create an employee handbook. Seventy percent of the agencies reviewed do not have an employee handbook outlining their personnel practices. When the analysts asked why, they were told, "We're a small agency and we work like a family. All our employees know what our rules are." Not having standard rules in writing and applying them fairly to all staff increases exposure to employee claims.
27. Prepare written job descriptions. More than 80 percent of all agencies did not have written job descriptions outlining duties and responsibilities for each workstation or job position. This, too, increases exposure to employee claims.
Many of these recommended procedures are simply good management practices. Nevertheless, it is astounding how many agencies are remiss in many of the areas. Using this list as a compliance checklist and eliminating problem areas will go far in reducing your firm's errors and omissions liability exposure.
Copyright 2000 by Edgar H. Lion. Used with permission.
Edgar H. Lion, BS, MS, JD is President and C.E.O. of
Alpine Risk Management Corporation, LLC
Note: Some E&O programs offer premium discounts for agency audits conducted by approved auditors. For more information, contact your IIABA state association.