Introduction:

According to the Insurance Information Institute, during calendar year 2000, individuals and businesses paid approximately 6,000 insurance companies $300.6 billion in premiums for property and casualty insurance and $435.4 billion for life, health and accident insurance protection.

It is estimated that on the average, businesses expend between $5 and $6 per $1,000 of their sales revenue to cover their cost of risk. A significant portion of the cost is allocated to the transfer of risk through the purchase of a variety of types of insurance. The remainder is attributed to risk management and absorption of uninsured events.

Because all but a relatively small handful of insurance companies sell their policies through independent insurance agents and brokers, few business managers elect to deal directly with underwriters. Rather, most rely upon the services of an agent or broker to help them procure the insurance they need. Here are some of the more important things business managers need to know when dealing with agents and brokers.

First, buyers need to understand the difference between an agent and a broker. By statutory definition, an agent represents the insurance carrier; a broker represents the buyer. Case law holds that when a sales person has contracted to serve as an authorized agent for more than one insurance company, that person functions as the buyer’s broker during the procurement process. After a policy is purchased, that person functions in the dual capacity as agent for the insurance company and as the buyer’s broker. The insurance industry refers to agents and brokers as producers.

Insurance producers are typically held to a standard of care based upon the custom and practice of others similarly engaged in the sale and servicing of insurance. Generally, producers only have an ordinary duty to procure the types of insurance specifically requested by the buyer. They are not obligated to advise the buyer as to the amount of insurance that should be purchased or any different types of insurance that may be available. Producers who agree to render advice relating to the types and amounts of insurance, policy terms and conditions, and other pertinent matters assume a special duty and are held to a higher standard of care.

Regardless of the level of duty a buyer expects the producer to assume, it is axiomatic that its insurance program will only be as good as the information provided to the producer. Buyers should treat their brokers as members of their management teams. The best way for buyers to obtain a true sense of financial security and peace of mind is to take their brokers into their confidence and keep them fully informed on a regular basis just as they do their lawyers and accountants.

Building a Solid Insurance Portfolio:

Whether buying direct or using an agent or broker, the insurance process starts by identifying the entities to be insured. Keep in mind that the purpose of insurance is to protect the business from the financial consequences of fortuitous events that damage property or injure persons bodily or otherwise. A complete list of all of the entities that are related through financial control, i.e. common ownership of 50% or more, and a thorough description of their business operations should be given to the producer. A list of non-owned or controlled entities such as lenders, lessors, independent contractors, and others that are to be included as additional insureds or require evidence of insurance must also be provided.

The next step is to identify where each entity is located and whether the real property is leased, rented or owned. If leased or rented, the broker should be given copies of the agreements. If the business is heavily dependent upon an offsite supplier of power, materials, parts, processing, assembly or other critical services, the locations and pertinent related details should also be provided.

Once the who and where has been established, the next step is to determine the what and howmuch. The what means buildings, tenants improvements, furniture, fixtures, equipment and other business personal property, automobiles and other tangible property including money, valuable papers, accounts receivable, etc. that should be specifically insured.

How much means the tangible value of the property measured by replacement cost and actual cash value. It also includes the amount of income generated by the business, the effect upon the business should an offsite supplier is shut down, and the value of any leasehold interest. Because the property, business income and leasehold values provided will be used to determine the amounts of insurance purchased, they must be kept up-to-date and accurate. It also requires an analysis of the businesses’ balance sheet to establish the amounts of third party liability insurance that may be needed.

A broad range of additional information must also be provided. Typically, insurance carriers prescribe the kind of information they need to determine the premiums to be charged for different types of insurance such as the square footage of each building, gross revenues, employee count, payroll, and etc. They also routinely require the names of the insurance companies that provided similar types of insurance during the previous three to five years and a detailed listing of the losses the carriers incurred under their policies. They also expect buyers to disclose whether any carrier canceled or declined to renew its policy.

A word of caution is required. Buyers must not conceal or misrepresent any information that may materially affect an underwriter’s decision to issue a policy. Materiality is subjectively determined by the underwriters who, upon discovery of concealment or misrepresentation, have the statutory right to void their policies. It is not the producer’s responsibility to determine the accuracy or thoroughness of the information presented. They are only obligated to submit the information provided by the buyer accurately and completely.

Relationship Defined:

After the foregoing information has been assembled, it’s time to identify the kinds of insurance desired. It is at this juncture that a producer’s duties are defined. If a buyer knows the types and amounts of insurance it wants, the producer’s duties will be limited to procuring the insurance specified. Otherwise, the buyer will depend upon the producer’s advice.

When relying upon a producer’s advice, it is important to remember that insurance cannot be purchased to cover every conceivable event that can cause financial loss. Virtually every insurance policy is subject to three types of exclusions; i.e. causes of loss that are, i) uninsurable, ii) insurable under a separate type of policy; and iii) insurable for an additional premium. Subject to certain exceptions, certain causes of loss, such as war, nuclear energy, intentional acts, breach of contract, and indemnification for punitive damage awards are typically uninsurable.

Types of Coverage:

The kinds of insurance available are broadly categorized as property, casualty, surety, life, health and accident. There are numerous sub-categories for each. For example, property insurance includes protection for buildings and other structures, chattel property including money and documents and business income. The property can be insured against damages caused by a wide selection of perils such as fire, windstorm, boiler explosions, burglary, etc. Casualty insurance includes bodily injury and property damage to third parties arising out of premises operations, products, operation of automobiles, professional negligence, officers and director’s liability, and workers compensation. Life, health and accident includes protection for individuals alone or as members of a group such as an employer, trade association, or a variety of other types of affiliation.

Although most underwriters use industry standard policy forms, many use their own forms or add endorsements to the standard forms to expand or limit the protection afforded. Buyers should expect the producer to inform them if any policy procured provides less protection than afforded by the existing policy(ies) carried.

Because business is in itself risky, it doesn’t make sense to purchase insurance against every event that may conceivably happen. The types and amounts of insurance to be purchased depends upon the buyer’s willingness to retain some risk based upon the benefits expected verses the cost of insurance. Most forms of property and casualty insurance can be purchased subject to deductibles or self-insurance retentions. Often the premium savings for selected retentions may be greater than the losses historically incurred.

Whether buying direct or through producers, insurance should not be purchased as a commodity. Those who buy insurance primarily on price seldom know what they’ve given up until confronted with a carrier’s denial of a claim arising out of an incident the buyer thought it had insured. Buyers are cautioned to beware of producers who ask to see copies of their existing policies on the promise they can beat the premiums.

Broker Duties:

It is a broker’s job to submit the buyer’s request for insurance to various underwriters to obtain premium quotations and commitments to accept the buyer’s offering. Broker’s have the duty to inform the buyer if the financial rating of any quoting carrier is marginal and/or the carrier is not licensed as an admitted carrier in the state in which the buyer is located. Depending upon the depth of the duties assumed, the broker may also suggest the use of alternative risk funding mechanisms such as the formation of a captive insurance company or placement with a risk retention or risk purchasing group. It is the buyer’s responsibility to make the ultimate decision at to the types and amounts of insurance to be purchased and to accept the underwriter. Producers are not obligated to order policies until they have received the buyer’s specific instructions to proceed and agreement to pay the required premiums.

Before delivering policies to the buyer, producers have the duty to check them to make certain they have been issued correctly. It is incumbent upon the buyer to also check them thoroughly to verify that all entities are appropriately named, locations are properly identified and the amounts of insurance are as ordered. Buyers should read each policy carefully and pay particular attention to their insuring agreements, exclusions, and conditions relating to what must be do to present a claim. If clarification is needed, it is the buyer’s responsibility to ask the producer to obtain an explanation. Wise producers will refrain from responding to questions requiring interpretation of policy terms and conditions and refer the buyer’s request to the underwriters.

In the event a loss should occur, it is the buyer’s responsibility to promptly notify the producer. Typically, producers will prepare the appropriate notice of loss forms and submit them to the carrier’s claims department. If a broker procured the policy through a wholesale broker, it is the broker’s duty to determine where the notice of loss form should be presented. Because wholesale brokers frequently do not have the authority to accept notices of loss on behalf of carriers, the buyer’s broker must check the policy to determine where the notice should be sent. Prudently, the broker will send the notice to the carrier and the wholesaler and require written confirmation of their receipt. Once the claim has been presented, most producers assist the buyer by guiding them through the settlement process and representing their interest.

Broker Compensation:

Buyers also should know how producers are compensated for the services they provide. Most insurance companies pay producers a commission based upon the amount of premium paid by the buyer. Depending upon the type of insurance, the rates of commission typically range between 5% and 20% of premium. Although many producers are reluctant to disclose the amount of commission they receive, buyers have a right to know because of the inherent conflict of interest. It is generally accepted that commissions compensate producers for their procurement of policies and routine services required to maintain the policies through their expiration, i.e. for the performance of their ordinary duties.

All too often, there is little correlation between the amount of service provided by producers and the amount of commission they receive. Like a two-edged sword, it can cut both ways. Producers may be under or over paid. Either way, buyers are affected. If they pay too much, it affects their businesses’ bottom line. If they pay too little, they may be short-changed on the services provided by the producer. Ironically, producers who do a superlative job for their clients often receive less for their efforts than those who perform marginally.

Buyers that pay in the range of $500,000 or more annually for their property and casualty insurance protection either employ a risk manager to structure their insurance programs or require the special services of an insurance broker. Either way, large buyers should ask the producer to work on a fee basis and procure their insurance on a net of commission basis. Commissions paid by carriers unwilling to quote net, will be applied to the fee. The fee concept minimizes the conflict of interest. It assures a win-win relationship by establishing a clear understanding of the services expected by the buyer and to be provided by the producer.

Conclusion:

In summary, buyers are the final arbiters of the kinds and amounts of insurance they elect to purchase. It is imprudent for buyers to assume that any gaps or voids in their insurance programs will be filled by the insurance carriers’ or producers’ errors and omissions insurance. Regardless of the advice and services rendered by producers, prudent business managers recognize that they bear the ultimate responsibility to make certain their companies are properly protected by the insurance they decide to purchase.