Insurance Agents: Targets for E&O Claims

In this section:

A Short History of E&O Exposure Development
What Drives E&O Losses?
What Constitutes an Error or Omission?
Common Causes of Errors
Sources of an Insurance Agent's Legal Responsibilities 
Common Law Duties of an Agency to its Insured 
Common Law Duties of an Agency to its Company 
Common Law Duties of an Agency to Others
The Laws of Agency
Authority of Agents
Statutory Duties of Insurance Agents
Conclusion

A Short History of E&O Exposure Development

For many years, insurance agents sought to be considered professionals in the same sense as accountants, physicians and attorneys.

When recognition as a professional finally was achieved, it came with a price tag. Like other professionals, insurance agents face legal action when their clients or others feel that the agent has not upheld the accepted legal standards for professional conduct.

Legal duties of insurance agents are based on peer standards, oral or written agreements (contract law), or statutes. The very fact that all states require that an insurance agent or broker become licensed before transacting insurance assumes that he or she will have the required knowledge to perform the activities necessary to provide the complex product of insurance to the public.

Three court cases helped to define the professional standards that must be adhered to by insurance agents.

In Hardt v. Brink (1961), the court said “this is an age of specialization and as more occupations divide into various specialties and strive for professional status, the law requires an even higher standard of care in the performance of duties.”

In 1984, a New Jersey court went even further by stating that “insurance professionals, because of the increasing complexity of the insurance industry and the specialized knowledge required to understand all of its intricacies…often stand in a fiduciary capacity to their client and should be required to use their expertise with every client” (Sobotor v. Prupac).

And finally, when agents were held in the same esteem as other professionals, an Idaho court determined that “a person in the business of selling insurance holds himself out to the public as being experienced and knowledgeable in this complicated and specialized field. In the interest of the state, the competent persons who become insurance agents are demonstrated by the requirements that they be licensed by the state, pass an examination and meet certain requirements. When an insurance agent performs his service negligently to the insured’s injury, the agent should be held liable for the negligence just as an attorney, architect, physician or any other professional who negligently performs personal services”.

Live by the sword, die by the sword!

This portion of the guide will discuss the current Errors and Omissions “climate”, highlight the evolution of errors and omissions claims against insurance agents and brokers, and discuss the major causes of loss.

What Drives E&O Losses?

Not surprisingly, Errors and Omissions claims against agents and brokers are on the rise. Recent studies have shown that the number of agencies expected to be involved in an E&O case has increased from one-in-twelve to one-in-three. This is due to a number of factors.

Product Changes

Insurers are constantly introducing new and more complex coverage forms and new exclusions that didn’t exist before. In the face of many more options, agents must be well versed on more topics than ever before. Training on these new coverages and forms, previously provided by the carrier, is generally lacking.

Changing Client Relationships

Agents fought for years to be recognized as professionals, held in the same esteem as the client’s attorney or accountant. This elevated status has been good for the agent’s image, but has also raised the standard of care and increased the likelihood that the agent will be involved in an E&O case. In addition, emphasis on long-term relationships with clients has meant that producers are expected to know more about the personal and business affairs of their clients and to provide adequate coverage in light of that increased awareness.

Changing Company Relationships

In the past, it was almost unheard of for a company to file an E&O action against one of its agents. Companies stood behind their producers, and generally did not take an adversarial position against them. This situation is changing rapidly. Insurers fight questionable claims more vigorously than in the past, and if called upon to pay, can and do turn around and sue the agent.

Strength of Plaintiff’s Bar

Agents and brokers have become a big target in the search for a “deep pocket” to pay for uncovered losses. While insurers are likely to fight claims, agents are more concerned with their reputation and ability to serve clients in the future and thus don’t provide the same level of resistance as the company.

Reasonable Expectations

In the past, clients looked to insurance to provide coverage for potentially catastrophic losses. Increasingly, they seek compensation for losses that the insurance professional does not regard as insurable for a wide variety of reasons. In an E&O case, the court is likely to impose the doctrine of reasonable expectations, or what a reasonable person would assume is covered by the insurance policy. This can be vastly different from what the insurance professional intended when arranging a client’s insurance. It has become more and more the case that all a client’s claims are covered…if not under their own policy, then by your E&O!

Emerging Exposures

Environmental liability and pollution, computers and the Internet, e-commerce and intellectual property, the Americans with Disabilities Act, employment practices liability, telecommuting and home-based business exposures; the list is nearly endless of new ways the agency’s clients can be exposed to loss. Product development to address these emerging exposures has been slow, at best, leaving agents with additional E&O exposures when the client’s needs are not properly met, or when coverage is unavailable in the marketplace.

Consumer Demands

The customers’ expectations are constantly increasing. Many want services quicker, better, and cheaper than ever before. Responding to the desires of the customer may put an agency at an increased risk for an E&O claim since speed sometimes comes at the expense of accuracy.

What Constitutes an Error or Omission?

An error is a mistake. We may have intended to do the right thing, but we made a mistake by not following through or performing a task incorrectly.

An omission is the failure to perform. We didn’t do something that we should have done.

Common Causes of Errors

90% of E&O claims are the result of an error, not an omission. There are reasons that errors occur, and if we can attack those reasons or causes, we have gone a long way toward reducing or eliminating E&O exposures in the agency.

Inadequate Training

Very few people intentionally do things incorrectly. Rather, they presume that they are acting appropriately and, in fact are, given their level of training and experience. There are many reasons (excuses) put forth by agents as to why their personnel are not adequately trained, but the most common are lack of time, lack of resources, and lack of motivation.

Lack of Uniform Policies and Procedures

Most people, in order to perform at their peak, require some kind of structure or “roadmap”. In most agencies, however, there are no written procedures or standards of performance. Without written guidelines, agency personnel are forced to act on their own best judgment in a variety of circumstances. While their judgment is generally sound, the problem is that each person tends to develop their own system of operation, some being better than others.

Lack of Consistency

Even if policies and procedures are put in place, they are often not adhered to by agency personnel. Treating one customer differently from another creates an inconsistency that can be problematic in an E&O case. Methods and procedures must be applied consistently in order to minimize the chances of an error.

Time Constraints

It’s interesting, but we seem to have no time to do things right, yet seem to find time to do things over. Haste leads to mistakes, and although we all know it to be true, we are also confronted with the increasing pressure to get more done in less time with fewer people. We can’t secure more time, but we can learn to use the tools we have available to make the best use of our time and eliminate the costly mistakes that lead to E&O losses.

Sources of an Insurance Agent's Legal Responsibilities

E&O claims are derived from the fact that agents owe legal duties to various persons who they serve in the insurance business. An insurance agent primarily serves two masters – the insured and the insurer. (In this context, an insured includes one who thought he or she was insured, whether they were or not.) On one hand, the laws of agency dictate that when acting as a representative of the insurer, the agent owes many duties to the insurance company or principal. On the other hand, the agent also owes duties to his or her clients. A growing and somewhat troublesome area of law involves duties owed to others who are not customers of the agent or the company.

The agent's legal responsibilities to the client arise out of:

  • common law theories of negligence, and
  • an implied contract to procure insurance for the insured.

The agent's legal responsibilities to the insurer arise out of:

  • common law theories of negligence, and
  • the written contract that ties the agency to the insurer.

The agent’s legal responsibilities to another person may arise out of:

  • Common law theories of negligence, and
  • An implied contract to procure insurance that benefits that person.

Common Law Negligence

Negligence is defined as "failing to do something that a reasonable and prudent person would do, or doing something which a reasonable or prudent person would not do." The criteria against which actions are measured, therefore, are subject to change over time, and the prudent person against whom one is measured is intended to be a peer.

It is clear from this definition and it's reference to a "reasonably prudent agent" that the actions of an insurance agent in a specific case will be examined and evaluated based on the facts and circumstances involved in that case. The standard against which an agent will be measured depends on the "state of the art" of insurance agency procedures and operations existing at the time of the loss. An agent's duty to an insured, therefore, constantly is evolving with the times.

For an agent to be legally liable for negligence, the injured party (the plaintiff) must prove the following:

  • the agent owed a legal duty to the plaintiff;
  • there was a breach of that duty by the agent; and
  • the damages suffered by the plaintiff were proximately caused by the breach of duty.

Professional or Salesperson?

One implication of the definition of negligence is that the higher the level of experience, education or skills involved, the higher the standard of care against which actions will be judged. Thus an insurance agent who holds himself out to be a professional through written or oral representations and appearances raises the standard of care against which actions will be judged.

Client Relationships

In addition to an agent's perceived professionalism, an established "course of dealing" or a "special relationship" with an insured can affect the degree of the agent's legal responsibility to the insured. If an agent consistently renews insurance policies for an insured over a period of years, for example, the agent has established a "course of dealing" and may then be held liable for failure to renew. An agent that counsels the insured on needed coverages, thereby creating a "special relationship" with the insured as an insurance consultant, can be held liable for failing to mention a coverage that the insured does not have in effect at the time of a loss.

General Duty to Act Reasonably

An agent generally has a duty to act as a reasonably prudent agent would act in the same or similar circumstances. Texas courts have defined the duty owed to the insured as follows:

"An agent owes his clients the greatest possible duty. He is the one the insured looks to and relies upon. The insured looks to the agent he deals with to get the coverage he seeks, with a sound company who can and will promptly pay claims when they are due. It is his duty to keep his clients fully informed so that they can remain safely insured at all times." (Trinity Universal Insurance Company v. Burnette - Texas, 1977.)

This general duty to act reasonably has been softened somewhat over the years by various court decisions that described certain specific duties of insurance agents.

Common Law Duties of an Agency to its Insured

Under common law, an insurance agent owes a duty to use the degree of care necessary to protect the interest of the insured. If failure to use care results in injury or damage to the insured, the agent can be held liable for the injury or damage. Of course, the agency is also responsible for the negligent or fraudulent acts of its employees and solicitors.

An agent's duty of care to a client is illustrated by the following common types of errors:

Misrepresenting insurance coverage

An insurance agent may not misrepresent the existence or the extent of coverage provided in a policy.

Failure to procure requested insurance

An insurance agent who undertakes to procure insurance for another owes a duty to use reasonable diligence in attempting to place the requested insurance.

Failure to notify insured of inability to procure insurance

As an expansion of the above theory, an insurance agent owes a duty to inform the insured promptly if unable to place the requested insurance.

Procurement of inadequate coverage

An insurance agent who agrees to provide insurance to an insured owes a duty to use reasonable care to obtain adequate insurance to meet the insured's needs.

Failure to maintain requested insurance

An insurance agent owes a duty to inform the insured when a renewal policy contains coverage changes.

Failure to inform insured of renewal

An insurance agent owes a duty to inform the insured of premiums due for a renewal when the agent receives information pertaining to the expiration date that is intended for the customer.

Failure to investigate an insurer's financial solvency

An insurance agent owes a duty to place coverage with a solvent insurer, reasonably monitor an insurer's financial condition, disclose solvency information to the insured, and protect the insured when the risk of insolvency becomes too great.

Failure to explain policy terms or coverage limitations

An agent may owe a duty to explain policy terms or coverage limitations, if the agent has a “special relationship” with the insured. See below for more information on this subject.

Duty to Explain Policy Terms

Does an agent have a duty to explain policy terms and coverages to customers? Does an agent have a duty to offer higher limits or additional coverages?

Generally, the courts have said the answer to these questions is "NO." As is the case with most E&O loss exposures, however, an agent can get sued for failing to explain or offer coverages, even if there is no legal duty to do so based on previous court decisions. That's why loss prevention measures are so important.

Client relationships can affect the success or failure of a client's claim against the agency. An established "special relationship" with an insured can affect the degree of the agent's legal responsibility to the insured.

If an agent counsels the insured on policy terms or needed coverages, for example, a judge or jury may say that the agent has established a "special relationship" with the client and may hold the agent liable for failing to explain a coverage or exclusion, or for failing to mention a coverage that the insured does not have at the time of the loss.

Without this special relationship, however, the courts have fairly consistently refused to blame the agent for a policyholder's failure to read and understand his or her policy, or for not providing coverage for every conceivable loss.

Common Law Duties of an Agency to its Company

An insurance agent may be liable to an insurance company for negligence or a breach of contract that causes loss or damage to the company.

In particular, the agent owes the insurer loyalty, fairness and honesty, and a duty to act in good faith and to keep the insurer informed of material matters that relate to the insurance or to the agency/company relationship. An agency may also be liable for the negligent or fraudulent acts of agency employees and solicitors.

The agency/company contract creates a "special relationship" between the agent and insurer, thereby increasing the required degree of care.

In addition, an agent has a fiduciary relationship with an insurer that requires an extraordinary degree of care.

An agent's duty of care to an insurer is illustrated by the following common types of errors:

Making mistakes

An agent owes a duty to use reasonable diligence and care in conducting business with its insurers. An insurer may be held liable for an agent's error in processing an insured's request for coverage, but the insurer may then have a right to seek indemnification from the agent.

Failing to follow company instructions

An insurance agent owes a duty to comply with a an insurer's instructions promptly and fully and may be liable for any loss the insurer incurs as a result of the agent's failure to do so.

Failing to disclose information

An agent has a fiduciary duty to the insurer to disclose any pertinent information related to the policies the insurer assumes for the agent.

Delay in forwarding information

An agent owes a duty to use reasonable diligence in forwarding information that has been requested by the insurer or is material to the insurance.

Exceeding the express or implied authority the company gives the agent

An agent owes a duty to understand and comply with binding authorities granted by the insurer and comply with all other terms of the agency/company agreement.

Common Law Duties of an Agency to Others

An insurance agent may be liable for errors or omissions that cause damage to persons with whom the agent has no customer relationship, such as lienholders, additional insureds and certificate holders.

An agent's duty of care to others is illustrated by the following common types of errors:

Failure to notify others of policy cancellation

An agent may owe a duty to notify lienholders and certificate holders when a policy is canceled.

Failure to advise when coverage cannot be placed

An agent may owe a duty to advise a lienholder when coverage requested by the lienholder is not placed promptly.

The Laws of Agency

“Agency” is a legal term that defines the relationship between a principal (individual or firm being represented) and their “agent” or legal representative.

Although we use the terms interchangeably, there is a difference between an insurance agent and an insurance broker in a legal sense.

An agent is the legal representative of the principal, or insurer, and as such owes his or her primary allegiance to the company.

A broker is the legal representative of the insured (except for collection of premiums) and owes his or her primary allegiance to the insured. Even though we don’t have an “insurance broker” license in Texas, there are many situations where a licensed “insurance agent” acts as a broker by definition:

  • When taking and submitting an application for coverage through residual market facilities such as Texas Auto Insurance Plan Association, Texas Windstorm Insurance Association, Texas FAIR Plan and Texas JUA; or
  • When taking and submitting an application for coverage with a company with which the agency is not appointed, such as through a managing general agency, surplus lines broker, or another licensed insurance agency. (See Brokering/Referrals/Sharing Commission on InfoCentral.)

Although we almost always feel as if we are the client’s representatives, we must be mindful that the law views the situation differently.

Authority of Agents

Agents derive legal authority from three sources.

Express Authority

The company/agency contract permits the agency to act on behalf of the company and defines the areas in which authority is granted.

Implied Authority

Although not expressed in the agency agreement, there is certain authority that is necessary in order to carry out express authority. For example, in order to bind coverage, it is necessary that an agency issue a binder, although that authority is not expressly listed in the agency agreement.

Apparent Authority

This type of authority, while not actual, appears to the insurance consumer to be valid, such as when an agency advertises that they represent a certain insurer but does not. If this authority is relied on to the detriment of the public, the agent can be held responsible to the company for any losses they may incur as a result of the agent’s creation of a situation of apparent authority.

Statutory Duties of Insurance Agents

Insurance Code and DTPA.

The Unfair Competition and Unfair Practices Act (Insurance Code Chapter 541) and the Texas Deceptive Trade Practices Act (DTPA – Business and Commerce Code Chapter 17) enumerate certain unlawful business practices of insurance agents and businesses in general that are considered unlawful.

Either one or both of these laws are almost always cited in lawsuits against insurance agents. The reason is simple: a successful claimant can walk away with the amount of actual damages plus court costs and reasonable and necessary attorneys’ fees. If the court finds that the agent knowingly committed the acts complained of, it may award two times the amount of damages in addition to the actual damages. The term “knowingly” is defined as “actual awareness of the falsity, unfairness or deception of the act or practice.”

The unfair practices cited by these two laws fall into two general areas:

  • marketing and selling insurance policies, and
  • handling claims.

The basic intent of these statutes is to prohibit unfair or deceptive practices or unfair competition in soliciting, selling, or servicing insurance, prohibit unfair discrimination in the pricing or sale of insurance, and prescribe a method by which insurers and their representatives may comply with the covenant of good faith and fair dealing in handling claims.

Defined Acts of Unfair Competition and Trade Practices. Some of the acts considered to violate these laws are:

  • Misrepresentations and false advertising of policy contracts;
  • False information and advertising generally
  • Defamation, meaning false or malicious statements concerning the financial condition of an insurer;
  • Boycott, coercion and intimidation;
  • False financial statements;
  • Unfair discrimination in rates or coverages provided;
  • Rebating; or
  • Using deceptive names, words, symbols, devices or slogans;

Other Laws

Many other sections of the Texas Insurance Code prohibit certain actions by an insurance agent and can lead to E&O claims, including:

  • making false or misleading statements as to dividends to be paid under a policy;
  • making misrepresentations to a policyholder to induce them to surrender, forfeit or allow any policy to lapse;
  • discrimination in property and casualty insurance based solely on geographic location;
  • discrimination in insuring residential property based solely on the age of the property; or
  • insuring property for more than its actual value.

Conclusion

Insurance agents make excellent targets for E&O claims brought by insureds, companies and others. The insurance business is technically complex, and the agent is subject to laws and regulations that are sometimes obscure. Perhaps the agent’s E&O coverage itself is to blame for many E&O claims against agents – the agent is sometimes the only one left standing with a convenient source of recovery for a aggrieved claimant.

Being a technical expert, following all the laws and rules, and implementing and enforcing fail-safe procedures may not keep you out of the courthouse, but all of the above will sure make it easier for your E&O carrier to defend you.