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E&O Legal Actions: The Agency Nemesis


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by Roy L. Phillips, CIC, CPIA and Dan R. King, CPIA

This article addresses an insurance agency's the most common practices that lead to Errors and Omission actions filed in court. Our information comes from our experience as principals in an agency and as consultants retained to review actions filed against fellow agents.

As principals, we are familiar with early-morning anxieties about coverage questions. Without that history of nausea, we'd have no credence in our consulting efforts in the face of E&O allegations. As consultants retained by E&O carriers, we are charged with the discovery of 'What actually happened?'

Attorneys for plaintiff and defendant attempt to describe the 'outrageous conduct that led to the damages.' Our client is usually the agent (defendant), although we have represented the interest of the insured and the carrier in dozens of cases in the last 10 years. Our job is to wade through the rhetoric of legal jousting in an attempt to find out if there truly is a Somebody-Done-Somebody-Wrong song. After wading through substantial pounds of pleadings, depositions, exhibits, interrogatories, and causes of action, we attempt to answer three pertinent questions:

1. Did the agency have a duty to perform on behalf of the insured? If so, what gives rise to that duty, and to what extent is the agency responsible?

2. Did the practitioner (agency) provide goods and services that are customary, expected, reasonable, and within the scope of the industry?

3. Was there a breach of any of the above by the agency that caused damages to the insured?

The first section of this article summarizes the myriad actions that present themselves from the time you join the battle against the 'Agency Nemesis.'

The moment you sign an application for a license to become an insurance agent, you assume a duty to perform services to any and all future insureds. The Texas Insurance Code directs the implementation of statute 21 within the state of Texas (our state), and is a companion to similar legislation within each state jurisdiction. The Code embodies much of the statute, but a prevailing duty is left uncommunicated.

The duty to act as you have agreed to has long been the adhesive of society. Without it, we would have one heck of a time agreeing with anything or anybody. The spirit of that duty is incumbent on every agent. In layman's language, it requires agents to make an effort to:

1. Become professionally aware of your products and make every effort to communicate that knowledge to every individual within your organization.

2. Apply that knowledge to the requirements of your insured through research and development of the business and personal activities of the client.

3. Find the applicable product and/or products to fill those needs.

4. Communicate the availability and pertinent issues of each product presented, using understandable written and oral communications.

5. Insist upon acknowledgment whenever the client rejects your opinions concerning exposures that you think require treatment.

6. Properly apply, receive, review, and transmit selected policies to the client, ensuring a continuity in all four actions.

7. Document the actions contained in No. 1 to 6 above, and be prepared to ensure that changes are made in a timely manner on behalf of the client.

8. Be prepared to show that procedures in your agency indicate a 'reasonable intent' to control actions 1 to 7 above.

Again, these are a condensation of the elements of a 'Duty to Perform.' We have arrived at this opinion from the dozens of cases we are retained to review each year. The next section focuses on specific cases from our files that substantiate that we truly have a 'Duty to Perform.'


After reading the section above, a fellow agent of ours indicated that it assisted him in making an important decision: to sell his agency.

It doesn't have to result in that dramatic a solution, if we followed the pulse of legal actions filed recently. Here are some actual cases from our files.

Case No. 1: Failure to Obtain the Proper Coverage

The insured had requested the agent to find appropriate coverage for his fur-cleaning firm. Unfortunately, the agent did not pursue the Bailee insurance resource that accompanies the cleaning and storage of valuable fur items. Award for the plaintiff (insured).

If that sounds like a simple mistake, take a look at this error in obtaining the proper coverage:

Case No.2: Failure to Obtain Proper Coverage

To maintain his business relationships with clients, the insured required general liability and other coverages. A certificate of insurance was issued indicating that the insured had all the proper coverages to meet the standards of contracts required by the client. The client, a general contractor, reported a loss arising from the work of the insured. The loss resulted in discontinuation of underground utility service to a major manufacturing plant. The insured, a swimming pool subcontractor, did not have coverage for the underground property damage. The insurance carrier for the general contractor responded to the loss, and then subrogated against the pool contractor. Finding for the plaintiff-who subsequently found another insurance-related resource: his agent's E&O policy.

These cases continue to occur, and the failure to obtain the proper coverage represents over 50% of the losses reported to our E&O carriers. They even exceed the secondary category of claims source: Failure to obtain any coverage.

Case No.1: Failure to Obtain Any Coverage

The insured instructed the agent to review his coverages and determine if he was adequately protected from loss arising from having to move his premises after a loss. Sounds a bit like a piece of coverage called Time Element, doesn't it? The loss occurred, and the extra expense monies were not in place to hire the mover, lease the new location, put in the phones, bring in new inventory, and notify customers of the change. Getting back in action was critical to his business (selling upscale formal gowns to the high school seniors who were graduating within the next few weeks). Finding for the plaintiff.

Case No.2: Failure to Obtain Any Coverage

The insured requested the agency to obtain coverage that would pay first dollar claims to his clients in the event their property was damaged through theft or vandalism. He was willing to pay the higher price since he was in the business of servicing Mercedes, Rolls Royce, Jags, BMWs, and other expensive toys. Vandalism occurred over the weekend, and the insured was forced to spend thousand of dollars repairing 11 vehicles left in his care. Primary garage keepers was not in place to respond, but you can guess what was: the agency E&O policy.

Failure to obtain any coverage represents 20% of the claims logged by E&O carriers. The cases just cited demonstrate the need for education among all the agency's personnel. These cases could have been avoided if agency personnel were trained to recognize the sources of claims and had continuing education in the products available to match client requirements.

The final two categories of claims sources are failure to bind coverage and failure to obtain renewal coverage. Although these represent only 10% of total claims reported, they demonstrate the increasing importance of prevention.

E&O Prevention: Packing Parachutes

At Fort Bragg, NC in the summer of 1959, we attended our first training class. It was titled 'How to Pack Your Own Parachute' and it was mandatory for all second lieutenants. The sergeant in command (the 77th Special Forces Group Airborne) was archetypically mean, demonstrating an obvious dislike for anyone wearing gold bars. He commented that he didn't care whether officers learned the right way or not (in rather more colorful language than is printable). He did, however, teach us a valuable lesson: Pack your own parachute the same way every time, because there's no such thing as a 'practice' parachute jump.

Prevention is like packing parachutes. When errors or omissions occur in our agencies it's usually because we didn't do something the same way every time. To avoid that inconsistency, one needs a system.

The final section of this article offers an outline of prevention. This information is based on 30 years of experience in a business that produces moments of rapture followed by hours of sheer madness. Our careers include time as:

1. A trainee underwriter attempting to learn what was covered in the contracts;

2. A crash-course adjuster during Hurricane Carla, attempting to learn how the coverage pays;

3. A branch manager (and later a vice president) of an insurance company, attempting to help agents create coverage that wasn't in place, but should have been (called accommodation);

4. An agent attempting to keep track of everything we are supposed to do in our 'duties to perform' for the insured; and

5. An expert witness who unravels the allegations of the plaintiff when things go wrong.

Just what is a systemic operational plan? The vast quantities of paper from insurance agencies alone must account for the depletion of our national forests. As a friend of ours says, where there's paper, there's trouble. He's a plaintiff attorney, and he's right. Attorneys and consultants in E&O cases search for 'tracks': paper trails (or lack of such). And problems invariably begin with the absence of a system.

A system is an established procedure for accomplishing designated tasks. It is goal-driven, and must have the dynamic quality of change. Let's begin with the engineering of a system tailored to the general business community.

Goal-generated tasks that business have in common include the development of products and/or services, for presentation to potential/existing customers, through a product-delivery system, with financial accountability serving as a barometer of success. All five elements exist in an insurance agency-but there's more.

Because insurance agents are practitioners of a very important service (the protection of client assets), they are charged with a high degree of responsibility in ensuring that client needs are met. The duty to perform is far in excess of the average retail business, but has a kinship with the potentially volatile nature of a CPA firm. Let's continue with our prototype.

An 'Agency Management System' is touted by every hardware/software vendor that services the industry, but automated or not it acts as a coordinator of several interrelated component members. For example, an Agency Management System:

1. Locates potential clients (marketing system).

2. Gathers data and analyzes needs (risk management system).

3. Coordinates risk to products (coverage system).

4. Approaches the marketplace (placement system).

5. Presents findings to the client (proposal system).

6. Implements selected products (application system).

7. Arranges for payment selection (accounting system).

8. Maintains interim service (service system).

9. Reviews changes in client profile (renewal system).

10. Maintains quality of staff training (training system).

Having defined these system components, it is important to remember that they are interrelated. As such, it is vital that they be driven by a single source. For example, if the agency is not automated, the standardization of paper files is an essential ingredient for maintaining integrity of data. Every file should contain forms and information that mirror its companion files for each account. Furthermore, any and all forms that comprise the record keeping of the nine systems above must be used the same way every time by everyone in the office!

The automated agency presents a new set of challenges. First, it is important to define automation. If the customer database includes only accounting information, the agency is not automated. Remember that accounting is only one system component. The truly automated agency is driven by a single-source customer database, which includes all customer transactions and is comprised of the nine components previously mentioned. It is characterized by its immediate retrievability, and all nine components are reconciled with an entry into any one functional system. Simply stated, the customer data on the screen represent the available information, as if you were turning the pages of the paper file.

Once the system is in place, two cardinal rules must permeate the minds of everyone in the agency. If Moses had been an agent, there would be three new Commandments:

XI. Thou shalt consistently perform all procedures the same way every time they are carried out!

XII.Thou shalt document all customer transactions, identifying date, time, recommendation and/or action, resultant action, and follow-up.

XIII.Thou shalt not allow any principal and/or producer to search out and destroy the system.

There are three offenders who will seek to destroy the integrity of all this: the principals, producers, and the long-term anti-system employees. What can you do about it?

Agency principals who actually think they operate the agency can be taught to be system-literate or to depend on someone who is for all transactions. Outside producers present another problem. Those who produce business must, of necessity, gather data. The integrity of that data has never been highly dependable. It is sometimes even void of any known body of insurance fact- but there's a solution. The producer must be equipped with appropriate forms that are native of the system. (In our opinion, any use of nonstandard forms, such as cocktail napkins, would be a breach of the system and therefore not system-friendly.)

With the employees who have been with the agency since the original tablets came down the mountain, you're in for a special treat. Anti-system staff personnel will either have to adapt or leave!

How do you find out if the system is working? You must audit the resultant transactional flow of the previously mentioned nine components. It must be done as a separate audit system, and should be effected by someone who can objectively examine paper or media trail. In other words, don't let the people audit their own trails.

Many agencies use Personal or Commercial lines managers for this important function. A manager can thus learn the strengths and weaknesses of the personnel they're supervising and find training opportunities.

The audit format should reflect agency policy concerning how each of the nine functional components is supposed to work. For example, if it is the agency's policy to offer Commercial Umbrellas to each account, then the audit documentation should reflect that this has been accomplished. The audit checklist should mirror the task list of each system component. One consultant client has found two approaches to the design and implementation of his audit system. The audit format was developed by the customer service representatives in accordance with what a complete file should include. Essentially, the CSRs worked as a team to develop the audit form. In addition, the consultant is in the process of placing his system task lists on his agency software program. This will provide immediate guidance for personnel wishing to review tasks requirements.

In conclusion, deploying the system we've described should not overwhelm you. It can be as simple as a notebook with standard operating procedures, or as extensive as your particular needs dictate. The point is that it should exist. Innovation and creativity have no place in the shed where parachutes are packed the same way each time!

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