Agent's Responsibility For Company Insolvency

Up until 20 years ago courts did not treat insurance agents as professionals and as a result agents were usually not held responsible for errors and omissions in situations involving the insolvency of carriers. With 'professional' status came the requirement that an agent must live up to professional standards of conduct. Court cases after 1957 have made it clear that an agent who holds himself out as being qualified to procure insurance is required to have adequate knowledge of the different companies and types of coverages available. An agent can be liable to the insured for placing a risk with an insolvent carrier if the use of proper diligence would have revealed the fact before the insurance was procured.

Until 1987 the primary question was whether the agent had used reasonable diligence in ascertaining the solvent status of the carrier. It was at least implicitly acknowledged that the agent was not a guarantor of the continued financial condition of the company from which insurance coverage is obtained. The Higginbotham v. Greer appellate court decision in that year, however, expanded the legal duties of agents. The court warned that agents placing coverage with carriers that are solvent at the time of placement may also be held responsible for damages if 'at that time or at a later time when the insured could be protected, the agent knows or by the exercise of reasonable diligence should know, of facts or circumstances' affecting the financial stability of the company and the quality of the insurance protection being provided.

Monitoring the financial condition of carriers has clearly become an on-going legal responsibility. It is also emerging as a public relations issue for agents. Comparisons between the insurance industry and the S&L situation are frequent fodder for the press. And the recent failures of several Life insurance carriers have served to fuel the flames. Insureds are demanding that agents have adequate information on insurance companies. It is part of the package of professional services that they are expecting the independent agent to provide.

Most of the E&O claims charging agents with lack of due diligence in selecting insurers that became insolvent have so far been settled out of court for small sums. But the number of cases is going up, and there is every reason to believe that awards will increase also. Some E&O policies provide coverage for these losses, others do not. Even if there is E&O coverage, agents stand to lose the deductible, valuable time, and possibly the E&O coverage if a suit is filed.

When legal action is not initiated by insureds, agents who went through the Mission or Iowa National debacles will nevertheless attest to the fact that the experience was very expensive and emotionally draining. Some states require agents to continue to pay accounts current to insolvent insureds and yet to stand behind their insureds for unearned premiums. This could add up to 25% or more of the agency's total premiums with that company. Insureds who purchase policies through an independent agent expect that the agent will keep coverage in force as long as they pay the premium on time. In the event of insolvency, the agent has to find alternate coverage, often with agency dollars. There is also a significant amount of personnel time involved in re-placing the coverage, time that could have been spent selling. This hidden cost of insolvency can be devastating. Considering the price that the agency may have to pay when a carrier goes under, insolvency control should be a major function of the management team. One individual should be given clear responsibility for tracking information on admitted and non-admitted markets used. Review all markets once a year (in conjunction with the general evaluation of company contracts), and develop an Agency Watch List. Companies placed on this list should be evaluated every month. The following is our checklist for standard companies. You should custom fit your particular agency circumstances, adding additional criteria for Surplus Lines as necessary.

The Middleton Group: COMPANY SOLVENCY CHECKLIST

SECTION I-SIGNIFICANT INDICATIONS OF FINANCIAL INSTABILITY:

Assign five (5) points for every YES answer on this portion of the checklist.

1. Best Rating drops below A- or goes directly from A+ to A-
2. Fails three or more ratios on NAIC IRIS test
3. Low S&P and/or Moody's ratings
4. Negative cash flow
5. Combined ratio higher than industry average and/or increasing rapidly
6. Any state (even if it isn't yours) taking action against the carrier
7. Premium finance companies refuse to finance their premiums
8. Umbrella carriers refuse to accept underlying coverage from that company

SECTION II-ITEMS THAT PROBABLY ARE INDICATIONS OF FINANCIAL DIFFICULTIES:

Assign three (3) points for every YES answer on this portion of the checklist.

1. Major executive level management changes
2. Frequent changes in auditors
3. Sale of assets
4. Stock prices declining
5. Premium to surplus ratio over 2:1 and going up
6. Dramatic changes in written premiums from one year to the next
7. Surplus growing faster than 10% a year (could be unstable growth)
8. Transfer of loss reserve portfolio (manipulation of the financial statement)
9. Consistently under-reserving on your claims
10. Questionable investments (junk bonds, too much real estate)
11. Agent grapevine is giving some negative signals

SECTION III-ITEMS THAT COULD BE INDICATIONS OF SOME FINANCIAL

DIFFICULTIES:

Assign one (1) point for every YES answer on the portion of the checklist.

1. Consistently poor business decisions being made
2. Information coming from branch inconsistent with information from home office
3. Employee morale down and turnover among underwriters up
4. Letter from company denying rumors (add extra point if you hadn't heard rumors)
5. Change in agency contracts, especially termination or profit-sharing procedures
6. Extensive changes in agency force (many appointments or terminations)
7. Makes erratic changes in underwriting authority, either more or less
8. Slowdown in paying claims
9. Slowdown in processing return premium endorsements and audits
10. Overall deterioration in service
11. Much lower rates or higher commissions than similar companies
12. Enters new lines of business or markets that other companies are avoiding
13. Sudden withdrawal from a territory
14. Concentrations of non-standard business in limited geographical area
15. Wholesale mid-term cancellations or non-renewals by line of business
16. Increased or decreased attention paid to collection of accounts current
17. Increase in accounting differences (charging for policies they haven't issued)
18. Change in reinsurance carriers, particularly if quality is questionable
19. Unusual dividend payments
20. Trouble with IRS or SEC
21. Increase in consumer complaints to the state insurance department

TOTAL POINTS. Companies with more than 10 total points and/or with a YES answer in Section I should be put on the Agency Watch List. More than 20 total points dictates the need for immediate action.

There are a number of states in which markets have become scarce for some lines of business. As a result, agents have been forced to take on all willing participates. While it is not inconceivable that one of the older national carriers could get into trouble, your primary focus should be on newer companies. A.M. Best Co. has developed a list of the characteristics of companies that have become insolvent during the last several decades, and 41% of them were under 10 years old.

Other items noted by Best's regarding the nature of recently insolvent insurance companies are:

• 75% were stock companies
• 62% had under $5 million in surplus
• 81% had unusual net premium growth
• 50% of insolvencies were due to a combination of rapid growth, underpricing, and deficient loss reserves
• 20% were due to fraud
• 15% were due to change of ownership or type of business written
• 15% were due to inadequate reinsurance protection
• Many were companies heavily involved in automobile insurance.

The whole issue of insolvency is so critical to the industry that it transcends the normal competitive guidelines under which agencies and companies operate. There is no other area in which cooperation is more critical. When one carrier goes under, it affects everyone associated with the industry, either in a direct financial way or indirectly through negative public attention.

Agents, whether or not they represented the insolvent carrier, will often take the brunt of the public relations flap and eventually be the ones that have to deliver the higher cost of insurance to the public. Insurance companies must participate in the guaranty funds, but the cost for the funding eventually can be traced back to the customer in all but a handful of states. Some states. Some states permit companies to recoup these assessments directly by increasing rates or surcharging policyholders. Others allow companies to credit the assessments against state premium taxes, which often go to support necessary community services, and the difference has to made up on other kinds of taxes.

Because all agents are in this together, we see an enhanced role for agents associations in the area of company insolvency protection. State and local groups can and should establish formal 'watchdog' procedures. Some associations do this now, but many do so only on an informal basis. This should be given top priority, particularly as many of the IIA and PIA groups are discussing the structure and focus of their new combined organizations.

Members that have reason to suspect problems with a carrier would have an established mechanism for reporting that concern to a central source: perhaps a small committee or specific individual within the association. There would then be a procedure to contact a designated person at that carrier to follow up on items that seem to be coming from more than one agent. For example, five agents report that XYZ Company is becoming very slow in paying claims, is even slower than before in getting policies issued, is losing a large percentage of underwriters, and is issuing incorrect accounts currents. These could all be signs of financial difficulties or they could simply be the results of the installation of a new computer system. Formalizing the grass roots grapevine helps qualify the rumors.

It would be nice if agents could sit back and wait for the NAIC, Dingell, and others to come up with tougher solvency rules and more effective regulation (state or federal-the operative word here is effective). But that is a luxury that cannot be afforded. Last year Standard & Poor's gave 133 insurance companies below-average ratings in Claims-Paying Ability, and they expect to continue downgrades in 1991. Insolvencies will continue to be of major and immediate concern for agents during the next several years.