Declaration of Independents.

Proper structuring of contracts with independent agents can reduce insurers' potential liability.

In all industries, employers and managers live in constant fear of the inevitable--the driver who gets into an automobile accident on the way to work and injures someone or the young engineer who inspects a home that later turns out to have structural defects. Insurance companies are no exception. The very same agents that insurance companies rely upon to sell their products to the public and create revenue are often the same ones that subject the company to liability.

Take the case of "vanishing premium" insurance policies that were created by insurance companies to combat rising inflation in the 1970s. As the name suggests, these policies promised investors that after making substantial premium payments during the first few years of the policy's existence, the policy eventually would generate enough cash value to cause annual premiums to "vanish." In as little as five years, an investor could be the recipient of a life insurance policy that guaranteed coverage and a rate of return for life, all without the obligation of having to make another premium payment. Investors purchased these policies by the millions and everyone seemed content--that is, until the bottom fell out.

Once interest rates returned to normal in the 1980s, these policies were not creating rates of return as they had before. This meant that the policy that had a cash value estimated to be sufficient to cause premiums to vanish in five years suddenly required payments for seven, eight or even 10 years. The result was the most costly and publicized insurance class-action litigation to date.

Though no vanishing-premium case has been tried on the merits, litigation costs and settlement proceedings have cost companies hundreds of millions of dollars. Prudential Insurance Company of America, for example, agreed to a class-action settlement that will cost the company more than $3.5 billion. The Prudential settlement covered about 10.7 million policies held by 8 million policyholders.

Insurance companies suddenly found that they were named as defendants in literally hundreds of lawsuits filed by ambitious plaintiffs' lawyers. This, despite the fact that many of these policies were solicited and sold to potential customers by independent contractors and other individuals who were not employed by the company but worked solely based on commissions.

These individuals were provided with company brochures and charts to assist them in soliciting these policies, but they were encouraged to use their own sales presentations. Nonetheless, it was the deep-pocketed insurers and not individual agents who faced accusations of employing fraudulent means to market the vanishing-premium policies. While most actions have been successfully defended, in that insurers have been able to defeat certification of the proposed classes, the vexing problem of vanishing premiums has proven to be an expensive lesson for insurance companies on the doctrine of respondeat superior--a Latin phrase referring to the doctrine that states the master is responsible for the actions taken by his or her servant during the course of duty.

The single most important question to be asked, however, is whether insurance companies can apply what they have learned from the vanishing-premium litigation to protect themselves in the future. As long as insurance companies continue to rely on others to sell their products, the problems posed by the vanishing-premium litigation are likely to appear again.

The doctrine of respondeat superior imposes upon employers, in this case the insurers, vicarious liability for negligent acts or omissions of their employee or agent that are committed within the course and scope of the person's employment or agency. Vicarious liability usually exists only if an employer-employee or agency relationship exists. On the other hand, someone who contracts for the services of an independent contractor is generally not responsible for the wrongs committed by an independent contractor. Insurers, then, can avoid liability if the "agents" they use to sell their insurance policies are deemed independent contractors rather than agents.

Making a Distinction

Numerous factors are used in making the distinction between independent contractors and agents, most important of which is the amount of control the insurer exerts over the efforts of the "agent." The more control, the more likely the person will be considered an employee/agent. While the difference often may seem trivial and one only of degree, in the end it governs whether insurers will be absolved of liability or face negative publicity and a judgment of sizable proportion. Insurance companies obviously face a catch-22 situation here, for there is a natural tendency to want to exert some control over the actions of individuals who sell the company's products and place the reputation of the company at risk.

In any event, to help ensure that an insurance company is not held liable for the actions of those who sell its products, the company should take the following precautions:

* Require the salesperson to sign a contract that defines the relationship as one for the contracting of independent services rather than a typical employer/employee relationship. The existence of such a contract will help to prove that the parties did not intend the relationship to be one of agency.

* Allow the individual significant latitude and discretion in the manner in which they perform their services. Again, the more control the company exerts over the individual, the more likely an agency relationship will be inferred.

* Encourage the contractors to use individualized sales presentations. Insurance companies generally have been successful in defending vanishing-premium lawsuits by demonstrating that the individuals who sold the policies used their own sales presentations and other techniques when trying to make a particular sale,

* Scrutinize all manuals, charts, literature, supporting documentation and other materials that are disseminated and provided to those selling the products. Regardless of the level of discretion provided to the salespeople, if the materials on their face are somehow flawed, the company may be liable--regardless of the sales pitch. Also be aware that the salesperson may manipulate these materials to help make a sale.

* Beware of the "captive agent," or the person who sells (whether voluntarily or involuntarily) only the products of one company. Never encourage or suggest to an individual that he or she sell only the products offered by your company.

Pertinent Rules

Insurance companies should not employ any of the following tactics:

* Require those that are not company employees to attend uniform sales training or seminars.

* Require the salespeople to enter into contracts that specifically defines "obligations" required of them. Again, the more control the company exerts will define the type of relationship that exists.

* Require individuals to sign contracts that prohibit them from selling other insurers' products for a certain period of time or geographic location. Such covenants not to compete strongly suggest the existence of an employment or agency relationship.

* Furnish the individual with transportation or subsidize traveling or transportation costs. For example, that eliminates paying an allowance for car expenses.

* Pay a salary. Not surprisingly, compensation in the form of a salary suggests an employer/employee relationship.

* Provide benefits packages. These include such items as 401(k) plans and medical insurance.

* Withhold taxes or Social Security payments from the contractors' checks.

* Carry or offer workers' compensation or unemployment insurance for individuals other than company employees.

* Provide office space for the contractors.

* Require union membership.

* Allow the individuals to be terminated at will or require them to provide a certain length of notice before terminating the relationship. An "at-will" relationship indicates the individual is an employee rather than an independent contractor.

Lance A. Harke is a senior partner with the Miami-based law firm of Harke & Glasby LLP. Jeffrey A. Sudduth is a litigation associate at the firm.