Insurance in Times of Financial Crisis

Fiduciary liability typically involves an employee suing an employer for not offering employee options for investing in a 401K plan, and the law weighs heavily in favor of the employee in these cases.

The current financial crisis affects almost every aspect of business life, including insurance. Businesses need to be aware of the legal issues covered by their coverages. Let’s take a look at a few of these areas, particularly employment practice liability, directors and officers liability and fiduciary liability insurance.

Employment Practice Liability Insurance

The number of employment-related lawsuits has significantly increased in the past few years, and award levels are setting records. It’s estimated there are more than 150,000 wrongful employment practices complaints currently filed with state agencies across the nation. With the large rise in claims, it may not be good business judgment for a company to rely merely upon loss-control techniques like a thorough employee handbook or a “zero tolerance” policy. EPLI coverage usually works with a deductible so that the smaller, expected claims do not generate adverse loss on the policy, which typically equates to higher premiums at renewal. Instead, the policy is used to protect the company from significant financial loss from large unexpected claims.

EPLI covers discrimination, sexual harassment, breach of contract, defamation, whistle blower, retaliation, negligent hiring, negligent supervision, and negligent retention. However, not all EPLI policies cover third-party harassment or discrimination claims, so if your client wants such coverage, be sure the EPLI policy specifically covers it. EPLI policies generally exclude intentional conduct from coverage. This is often an issue with sexual harassment claims, but usually the exclusion only pertains to violations that are proven to be intentional or deliberate by a judgment or other final adjudication.

Most EPLI policies give the carrier the right to select defense counsel, but companies often have their own lawyers who are familiar with the company’s owners, employees and daily operations. However, the insurer’s contractual right to control the defense (and therefore the right to select counsel) is overridden by the common law where a conflict of interest exists between the insurer and the insured.

An insured that is concerned about this issue should negotiate with the carrier to put language into the policy that the insured can choose defense counsel at rates commonly used by the carrier. If your client is already in litigation and the insurer is providing a defense under a reservation in which the facts to be adjudicated are the same as the facts in the coverage dispute, then your client may have a good argument that it has the right to retain the defense counsel of its choice.

Fiduciary Liability Insurance

This is a hot topic recently among practitioners because of the Enron debacle. Fiduciary liability typically involves an employee suing an employer for not offering employee options for investing in a 401K plan, and the law weighs heavily in favor of the employee in these cases. ERISA protects the interest of plan participants and their beneficiaries and defines the liabilities and responsibilities associated with the management and administration of an employer’s health and welfare, pension, profit sharing and other employee benefit plans. Additionally, COBRA and the Retirement Protection Act of 1994 create additional compliance issues for fiduciaries. Finally, the increase in employee stock ownership plans creates significant liability for fiduciaries.

Fiduciary liability insurance is appropriate for any company that sponsors a retirement plan, such as a defined benefit plans. Regardless of the size of the company or the number of plan participants, if a company sponsors any of these plans, the company should have fiduciary liability insurance.

Directors & Officers Liability Insurance

D&O polices are created to protect companies and their directors and officers from liabilities arising from actions taken by the directors and officers themselves in their corporate capacities. In other words, the policy attempts to protect the good guys from the bad guys within the same corporation. Of ourse, not all policies will cover intentional wrongdoings. Whether or not an intentional wrong or a criminal act is covered under a policy will most likely be determined by the definition of “loss” under the policy.

Recently, there has been an influx of declaratory judgments and rescission actions by insurers to rescind policies due to misrepresentations or omissions in insurance applications. Typically, before an insurance policy is created, a D&O insurer will require various types of financial information through an application process. The insurers need to review financial statements, annual reports, corporate bylaws and claims history. An insurer will rely on this information in evaluating risk and determining policy premiums. It is extremely important that each document submitted to the insurer is accurate and that any forms filled out by corporate representatives are truthful. If any of the information the insurer relied upon in drafting the policy is found to be false or misleading, the entire policy could be rescinded as to every insured.

Another concern is the Sarbanes-Oxley Act (SOX) signed into law in 2002. Its purpose is to protect investors by improving the accuracy and reliability of corporate financial reporting. SOX creates an independent auditing-oversight board under the Securities Exchange Commission, imposes white-collar criminal penalty enhancements for criminal fraud offenses, provides for enhanced and more extensive corporate financial disclosures and reporting, and creates an enhanced recourse procedure and safeguards for those harmed by securities fraud.

A corporation looking to cover the risks created by SOX should also be aware of an exclusion often found in D&O policies, the “insured v. insured” exclusion. Usually, these exclusions will state that certain claims are covered as long as they are not brought with the solicitation or assistance of any director or officer of the company. Generally, this provision will pertain to former officers and directors as well as current ones. Therefore, if a corporation lets a director go and he solicits or assists in a claim against the company, that claim will probably not be covered because of the insured v. insured exclusion.

Conclusion

As we work through this financial crisis, we will see how courts deal with the increasing claims against businesses and financial institutions, and likewise how the insurance coverage issues raised by the crisis impact insurers. In following the rise of claims and the legal issues that ensue, we hope to discern the trends that will allow agents, brokers and carriers to give proper and timely advice to insureds.