Evaluating exposure Featured

7:00pm EDT January 26, 2009

Evaluating your company’s insurance coverage is a complex process. Many companies have numerous policies, including general liability, directors and officers (D&O) liability, errors and omissions (E&O) liability, and employment practices liability, to name a few. Evaluations should be held at least annually.

“Premiums are not the only issue,” says J. Ronald Ignatuk, a partner in the law firm of Shulman Hodges & Bastian LLP. “Companies change. They may embark on a new enterprise or new line of business that increases not only the potential that they may be sued but the amount of damages sought in the lawsuit. Companies need to regularly evaluate their exposure.”

Smart Business spoke with Ignatuk about the evaluation process and potential insurance issues.

What factors should risk managers consider when evaluating the amount of coverage?

The evaluation process depends upon the nature of the business and the risks presented by offering the goods and/or services to the market. For instance, if a company manufactures all-terrain vehicles, injuries to someone using that product could be severe, and fatalities could result, prompting a substantial product liability lawsuit. For this company, a large amount of indemnity is recommended. Conversely, if a company manufactures envelopes, potential exposure for injuries from use of the product is small and less indemnity is required.

The company’s risk manager should work with insurance brokers, who are the most qualified to advise them regarding the amount of coverage and the potential exposure. The risk manager also can consult with legal counsel, who can be a valuable source of information about lawsuits in similar industries.

With other types of coverage, such and D&O liability coverage, careful analysis should be performed regarding potential exposure of the board and corporate officers. Likewise, with E&O, careful analysis should be performed regarding potential exposure related to the business operations of the company and potential harm that those operations could cause.

What should the risk manager consider when increasing the amount of indemnity?

If it is determined that more indemnity coverage is advisable, then the decision must be made whether to replace the existing policy or purchase an umbrella policy (or increase the limits on an existing umbrella policy) that provides additional indemnity after the first policy’s limits have been exhausted. ‘Stacking’ two or more policies provides additional levels of indemnity.

Umbrella coverage is generally inexpensive compared to the primary underlying policy because it isn’t implicated unless and until the limits of the primary policy are exhausted. However, the umbrella coverage may not contain certain features that may be required. For example, the umbrella policy may only provide indemnity and may not cover other expenses, including defense costs.

When should a company consider switching insurance companies?

While a different company may offer a more attractive premium, that is not the only consideration. The risk manager must also consider the impact of changing carriers.

One important factor is whether the company has already incurred liability for something it has done, which the new insurance company may not cover if a claim is made against the company for that past act. When applying for a new policy, the company must disclose on the application all known claims and known acts and omissions that might give rise to a claim. Any claim arising from these disclosed acts and omissions is excluded from coverage. Thus, if the company is aware of significant potential claims, it may want to keep the existing coverage.

How important is an accurate application?

If the company omits an important fact on the application — even if the omission was inadvertent — and a lawsuit completely unrelated to omitted fact is subsequently filed, the insurance company can, and some will, rescind the entire policy, leaving the company without any insurance. The omitted fact does not need to be related to the lawsuit. As long as the omitted fact is considered ‘material’ to the insurance company’s decision to issue the policy or the amount of premium charged, the insurance company may have the right to rescind the entire policy, thereby avoiding any obligation to defend the unrelated lawsuit or pay any judgment. When changing insurance companies, great care must be taken to disclose everything on the application. D&O and E&O policies are more prone to scrutiny of the application after a claim is made than a general liability policy.

Do insurance companies always engage in good faith claims handling?

Insurance companies generally defend lawsuits and pay judgments when there is little or no dispute regarding coverage. For more complex matters, they usually hire outside counsel to render a coverage opinion. When coverage is questionable, insurance companies may agree to defend and indemnify, and sometimes they do not. In the latter case, the company needs to retain competent counsel experienced in insurance law to press the insurance company to defend the lawsuit.

J. RONALD IGNATUK is a partner in the law firm of Shulman Hodges & Bastian LLP. Reach him at (949) 340-3400 or rignatuk@shbllp.com.