Katrina's next wave: agents' E&O coverage could become the next liability target nationwide.

In June 2005, at the start of the worst hurricane season on record, Elmer and Alexa Buente bought a new home in Gulfport, Miss. Just a few months later, Hurricane Katrina crashed into the Gulf Coast, severely damaging the Buentes' new home. The home was damaged by Katrina's storm surge, a wave of sea water pushed by the hurricane. Though they did not have flood insurance from the federal National Flood Insurance Program, the Buentes assumed the damage would be covered.

After all, their Allstate agent allegedly "expressly represented" to them that "any and all hurricane damage," including storm surge, would be covered by the hurricane policy they bought, according to a lawsuit the couple has filed against Allstate Insurance Co. The suit also alleges that when the Buentes specifically inquired about flood insurance, an agency employee assured them they did not need flood coverage because they did not live in a federally designated flood plain.

But flood damage was excluded from the policy the Buentes bought and storm surge is considered a flood.

The Buente vs. Allstate case, and others like it, are examples of the kind of legal action that could trigger errors and omissions insurance claims from independent insurance agents in Katrina-affected areas. And it is the kind of case that may become more common as the Katrina wind vs. flood lawsuits peter out, experts predict.

"These (wind vs. flood) lawsuits have tried to go straight at insurers and the flood exclusions, but they haven't gained any ground," said Ann Spragens, general counsel for the Property Casualty Insurers Association of America. So plaintiffs' attorneys may very, well turn their gaze to agents and brokers instead, Spragens said. But they will have to prove misrepresentation, either deliberate or unintentional, by the agent to win.

"The question is going to be did they represent the coverage in a misleading way," said Finley Harckham, a partner with the Anderson Kill & Olick law firm. "The answer is going to be very specific to the agent or the broker. They could be liable if what they are doing is a deliberate misrepresentation of a product."

Harckham said plaintiff will have to claim the agent or broker steered him or her to a product that did not cover all the perils, such as storm surge, when the client "specifically told my agent or broker I need all coverages for hurricanes."

But much of the evidence in these types of cases is hearsay, Spragens said. "How do you prove there was a material misrepresentation? It's not an easy case to win."

Evidence, Harckham said, could come from agent advertisements and Web sites. "Even when you have evidence, it is hard to hold the agent or broker to that," he said. "It's going to be hard to prove and it's going to be fact-specific. But because they are so fact-specific, it may be hard to easily get rid of these cases."

In the end, it will come down to which side makes the better case, Spragens said. And a "sympathetic jury" could decide the case, she said. How early cases alleging agent and broker misconduct are settled will determine whether more are filed in the near future, Spragens surmised.

"You never know how the courts are going to rule on these," said Etti Baranoff, assistant professor of insurance and finance at Virginia Commonwealth University's Risk Management and Insurance Studies Center and a former Texas insurance regulator. "We are a very litigious society and the deep pocket is the insurance companies."

Baranoff said agents do not explain every exclusion of a policy, nor are they responsible to tell clients who do not live in a federally designated flood zone about flood insurance. "Therefore, in what way is the agent liable?" she said. "Does the agent ever go over every single line of the policy? It's too many details."

Lessons Learned

While Tom Sandahl of Wright & Percy, an insurance brokerage in Baton Rouge, La., doesn't give much credence to most of the allegations being leveled against insurers and agents, he said the "industry certainly isn't lilywhite." Lessons were learned from Katrina, he said.

"A phenomenal event like this teaches a lot of people a lot of things," Sandahl said. "The biggest lesson learned: the definition of flood. Flood is a lot of different things. It's the largest area of misunderstanding."

"While the policy language is explicit," many people, including some agents, were unaware that storm surge is considered a flood event, he said.

The second lesson is flood insurance covers only flood and policyholders do not receive many of the same benefits as they would under a homeowners policy, such as living expenses, Sandahl said. Likewise, for commercial properties, flood coverage does not provide business interruption, something some policyholders were unaware of. "Those are major losses that are going uncovered," Sandahl said.

Florida did not bear the brunt of Katrina, but Bill Lockhart of Advanced Insurance Underwriters in Hollywood, Fla., said "agents' E&O has indeed been a problem" stemming from the state's share of storms.

"The biggest problem as far as hurricanes are concerned, is not structuring the insured's property program correctly," Lockhart said. "Most insureds, particularly smaller accounts, don't understand insurance. They are accustomed to focusing on lowest cost, and there are a plethora of agents who sell only on cost. Then, when the insured's property blows away, they find out they are not covered properly, and sue the agent."

Lockhart said undervaluation is "the biggest problem" that can lead to an E&O claim. He noted he recently lost a service station account. His values were based on a recent appraisal, which indicated values be increased. Another agent cut values, and the station did not get law and ordinance coverage because the other agent did not explain it properly. The statewide Florida building code will require significant upgrades if damage is enough to trigger the code, generally 50% or more to the building.

"The other agent misadvised the insured in order to offer a lower price. I offered proper coverage which came at a higher price," Lockhart said. "Would the insured have an E&O case against the other agent if there was a loss? I think only if I were willing to testify on their behalf, which I wouldn't be. In this case, from my viewpoint, they made an informed choice and must suffer the consequences. If an insured makes informed choices and suffers the consequences, they don't really have a good case against their agent."

But, he said, if the agent misrepresents how his program will respond to a loss, then the agent is "wide open."

"The basic problem, and the source of any E&O exposures from hurricane losses, is that tar too many agents do not understand property insurance," Lockhart said. "They do not know the various coverages and the small details, such as what they cover and how they work. That means they can't properly educate the insureds. And they can far too easily err in representing how their programs will work. The insured finds out the real truth in their second conversation with the adjuster."

Using a Checklist

So what is the solution? Florida adopted a checklist for agents and brokers to use while selling insurance. And Louisiana's Legislature is also considering a checklist. Lockhart said he already uses his own "more comprehensive checklist."

"I like the idea of a checklist. If they have a checklist, the agents will be protected," said Baranoff. "To me, it's very necessary."

Sabrena Sally, second vice president and underwriting manager for GE Insurance Solutions' E&O writer Westport Insurance Corp., said "any time there is an established standard of care across the board, it has a mitigating effect on claims."

"The number of 'he said/she said' type claims would be reduced and the ability to defend the agent would be increased," she said. "We definitely encourage the use of written documentation."

Harckham, however, said checklists "could be very problematic for agents and brokers" in some states. He said they could "change the legal landscape" from one in which agents and brokers were not obligated to recommend coverages to one in which they could be liable if they did not.

"It just adds another layer of confusion to this issue," Harckham said. "They're just adding another potential defendant in the chain of liability by trying to pin that on the agent or broker."

Sally said this could be the case in states that "look on the agent as basically an order-taker" but said other states already "have a higher standard of care."

Sam Miller, executive vice president of the Florida Insurance Council, said his organization supported "the concept of the checklist" in Florida. However, he noted the checklist and several other new notice requirements "dramatically increased the size of our mailings and add additional expense."

"One company says the introduction to its policy went from three pages to 12," Miller said.

Sandahl said a Louisiana agency has already come out with a checklist, but he was not a fan of it because, while a good idea, it was just too complex.

"The checklist I saw was 20 pages with 20 items on each page," Sandahl said. "No insured is going to spend the time to go through that and understand it. It needs to be user-friendly: I'm all for it, I think it's great. But it has to be understandable and easy to use."

Otherwise, it is just "something to pull out of the drawer" so the agent cannot be sued, Sandahl said.

Controversial Solution

Sandahl said he believes he knows the solution to legal exposures following hurricanes and other storms.

"The answer is a combination policy," he said. "There just needs to be one policy."

Sandahl said this combination policy would cover all perils to make the adjusting process "seamless to the insureds." Insurers, he said, would be reimbursed by the government for any flood losses covered. As it stands, the current system, where insureds are caught in the middle of trying to prove wind or flood damage, is a "haven for attorneys," Sandahl said. And the maximum coverage limit of $250,000 for flood policies, with the number of expensive homes on the coast, breeds a position where the policyholder would much rather his loss be a wind one as opposed to flood, be said.

But insurers have not been open to the idea in the past, citing the high premium such a policy would demand and other factors. Joseph Annotti, PCI spokesman, said his organization has "some hesitation" about a combination or all-perils policy, though he said "it would certainly end the confusion" over flood coverage.

"There's no way to spread the risk," Annotti said of flood coverage. "The risk is catastrophic in nature and it happens over and over again in the same place. That's why the private market won't insure it."

In addition, Annotti said a combination policy also would create "a dicey political question." Since all policies would have to offer flood coverage under a combination policy plan, he said it would be more akin to a "flood tax" on all property owners instead of the current NFIP structure. A state such as Arizona, with little flood risk, might object to higher costs to subsidize flood coverage in other parts of the country, he noted. In the end, Annotti said, it is up to the U.S. Congress to decide how to reform the flood program.

Sandahl admits a combination policy "may be a pipe dream," but insists it is the best way to eliminate the majority of lawsuits following a hurricane.

"Unless we come up with some kind of combination policy, we'll be right back where we are right now again," Sandahl said.

Key Points

* Agents' E&O claims stemming from Hurricane Katrina could increase as wind vs. flood lawsuits fail.

* Plaintiffs will have to prove agents misrepresented policy coverage in order to win lawsuits.

* A checklist may help protect agents and brokers from future E&O claims.

Few Big Players in the Agent/Broker E&O Market

Agents and brokers' errors and omissions insurance is a $500 million market with few big players. Only five or six companies write agent E&O, said Sabrena Sally, second vice president and underwriting manager for GE Insurance Solutions' Westport Insurance Corp. But there are more carriers now than four years ago as some new writers have entered the market.

One of the oldest and biggest is the Independent Insurance Agents & Brokers of America's arrangement with Westport, which writes about 60% of IIABA's 300,000 members, according to David Hulcher, director of agency E&O risk management for the association. Other top writers of agent E&4) are Firemans Fund Insurance Cos. and Utica Mutual Insurance Co., according to Hulcher.

Kurt Pearsall, vice president of Utica's E&O program, said his company is the second-largest E&O writer for independent agents, with about $75 million in premiums and 11,000 customers.

Almost all independent agents buy E&O coverage, Hulcher said.

"First off, they're crazy not to," he said. "But pretty much every carrier requires agents to carry E&O in order to do business."

Meanwhile, captive agents who exclusively do business for one insurer or group are generally covered under that company's corporate coverage, Sally said.

E&O covers the cost of defense and damages from legal claims, but not all E&O coverages are equal, Sally noted.

Westport's agent and broker's E&O policy has a minimum $1 million liability limit. Depending on the size of the agency, agents can buy up to $15 million in liability coverage. The average is a $2 million limit, Sally said. Mark Wolf, assistant vice president of agency E&O operations for IIABA, said this is driven by the fact that many of their clients are smaller agencies with smaller premium volumes.

Utica offers liability limits as low as $500,O00--though "very few agents buy that low," Pearsall said. Utica's median liability is also $2 million, and it writes up to $20 million, he said.

So far, Hurricane Katrina has had a "minimal impact" on E&O claim frequency, Sally said.

"We have not seen an increase in requests for coverage since the hurricanes," she said. Nor have agents sought higher limits following the storms.

Utica had a total of six E&O claims stemming from Katrina, Pearsall said. "We have seen some activity" he said. "We do expect we will see some more." But he is also unsure how many claims will come this late after the storm.

Katrina may cause an uptick in frequency in E&O claims in general, however. According to a Towers Perrin Tillinghast report, there is "a 'buzz' that may lead to suits alleging negligence by insurance agents." These suits would trigger the agents' professional liability insurance E&O coverage.

"What we have seen historically, there aren't more errors and omissions," Sally said. "You might see more frequency historically, because the hurricane lends itself to uncovering it."

Sally said there could be a potential long tail to the event "simply from the fact that people and business have not been able to get back to inspect their properties and file claims."

Pearsall said that before Katrina, E&O claims frequency was declining significantly and had been for a number of years. He said this was a result of agents around the country "doing a good job of protecting themselves from E&O claims" by making sure their policyholders had the right coverages and carefully explaining coverage.

Learn More

Westport Insurance Corp.

A.M. Best Company # 02301

Distribution: Brokers, select managing general agents and program administrators

Utica Mutual Insurance Co.

A.M. Best Company # 00946

Distribution: Independent agents and brokers

For ratings and other financial strength information about these companies, visit www.ambest.com.

What is E&O?

Errors and omissions coverage is a professional liability policy covering the policyholder for negligent acts and/or omissions that may harm his or her clients.

Source: Insurance Information Institute

At a Glance: Agents and Broker's E&O

$500 Million

Size of the agents and brokers' E&O market

5-6

Number of insurers that write agents and brokers' E&O

$2 Million

Average liability limit of a single policy

Source: Independent Insurance Agents and Brokers of America and Westport Insurance Corp.