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Shedding light on black holes in insurance protection.

Black holes in space, as in the insurance market, are remarkable for many reasons. They pierce time and space, cannot be seen and draw matter into themselves. Once enmeshed in a black hole, an object is "gone." In addition, one can only suspect the existence of black holes by measuring their effects.

In a variety of insurance situations risk managers must deal with uncertainties, which can also be referred to as black holes. These questionable areas can be narrowed down to five major types: differences between occurrence and claims-made coverage, relating indemnification to hold harmless agreements and insurance, misunderstanding who is or should be insured, gaps surrounding limits and exposures and self-insurance problems.

When occurrence coverage was introduced to broaden accident coverage and provide a measure of "continuous or repeated exposure" protection, most insurance companies in the United States adopted a similar definition. As limits to occurrence coverage eliminated what was perceived as bad law, such as retaining pollution within accident coverage, most companies again adopted similar language. This has not been the case under claims-made coverage. It should be noted, however, that claims-made impacted medical professional liability early by changing the prior per claim coverage to claims first made during the policy period.

As a result, there are many variations between claims-made and occurrence policies, depending on underwriters' creativity and reaction to changes in coverage. For example, retroactive dates may or may not vary for each company within the insured's group of companies; firms differ on whether to handle a claim when the incident occurs or when it is first reported; and late or extended reporting may be as short as 30 days or as long as two years, depending on statute. In addition, retroactive dates may be muddled by additional exclusions or limitations regarding certain losses or specific subsidiaries. Finally, excess coverage may not address any of the aforementioned scenarios.

These variations affect policyholders in many ways. One financial holding company had several retroactive dates as well as additional limitations, which complicated the process of identifying actual protection. A municipality, when presented with a late public official claim, had difficulty understanding the hole into which the claim fell. A university moved from one claims-made policy to another because of price only to find a black hole created by differences in provisions. In another instance, a blood bank, even after purchasing retroactive cover, reported a late loss to the former claims-made carrier and only narrowly avoided a refusal for coverage by the new carrier.

Other problems with claims-made and occurrence policies include changing terms, definitions and exclusions by insurance company and by year. Therefore, risk managers must know the time periods involved, the entities to be covered, the limits provided and the exposures included under both policies to avoid this black hole.

Indemnification and Hold Harmless

What should be a simple analysis is complicated by the multiplicity of contractual interests and clauses imposed on insurance and risk assumption or transfer. An indemnification agreement usually provides for defense and indemnification of any and all claims. This agreement immediately extends beyond bodily injury caused by an occurrence and arising out of specific exposures. However, the promise of defense for various parties is not always granted in an insurance policy.

Adding to the problem is the legal impediment in many states to assume liability for the negligence of others. Some contract drafters have tried to address this problem by referring only to assumption of liability arising in part from the insured's actions. Although the intent is good, it is uncertain how, under a specific set of facts, a court would interpret coverage.

Perhaps the most difficult problem arises from multiple agreements covering the same events. Many contracts, for example, contain a hold harmless clause, an insurance requirement and an indemnification provision. Some exceptions to the contract requirements include socalled acts of God. However, these exceptions may be poorly drafted. In fact, one oil contract exception was so broad that it voided the entire assumption requirement. The situation may be further complicated by subcontractor agreements. This is particularly true of drilling contracts because of the number of conflicting clauses and interests. Another problem occurs when the insured, as fiduciary for a management company or oil non-working partner, acts for other interests. If the insured's approach varies regarding specific undertakings for the same interests, a serious black hole may result.

Other contract discrepancies include specific language concerning severability, state cap requirements and determination of disputes and where the suit may be filed. Finally, the inequality of contracting parties creates additional risks. Many large suppliers and purchasers seek to force their own contract language on the smaller party. An interesting outcome resulted when a major energy company, while insisting on transferring all liability, ignored the importance of the severability clause, making the contracts available in all states prohibiting transfer of sale negligence liability. In another instance, a city contracted with a water authority for the supply of water, assuming that some responsibility existed with the authority for water treatment. However, the contract stated that no responsibility existed for testing or for any implied potability of water.

Who Is or Should Be Insured?

Perhaps no area is more important, less understood and more mishandled than determining who will receive insurance protection. Often a simple array of insureds grouped by type of coverage for the same named insured will significantly differ even among liability policies. It is impossible to determine who is or should be insured without knowing all the companies owned and managed by the entity, as well as all other companies involved in a cooperative or joint venture relationship.

In one case, two entrepreneurs who owned and operated a financial management company could not agree on which interests, properties, managed entities and joint ventures they should identify. Several months passed before a list addressing the question of who should be an insured was completed, during which time serious gaps in coverage existed. Another situation, involving an energy complex started by an entrepreneur and transferred to his family, resulted in similar difficulties. Not only was the entrepreneur prolific, but so were many of his heirs. Trying to relate all interests and entities, particularly when some family members were not sure they wanted to be involved in the venture, resulted in many discussions, memorandums and resolutions.

Perhaps the most deceptive aspect in determining insurance protection is the assumption that broad liability and excess and property coverage is in place and all entities are properly protected. Often the risk manager is kept in the dark because he or she is not considered part of the management team privy to confidential corporate information. Moving past this closed door requires tact, intelligence, information and a determination to do what is best for the corporation.

Another danger in identifying insureds occurs when companies are bought, phased out, sold or transferred. Although liability may flow through time due to legal precedents, black holes will continue to exist because the concept of the corporation is often misunderstood to mean the surviving corporation. As a result, liability for a prior company's actions is sometimes conveniently forgotten. Therefore, verifying the stream of entities over time is important.

Joint ventures are often misunderstood by insurance purchasers. Undesignated joint ventures result in no coverage for any venturer in the activities. This exclusion extends beyond primary liability to the excess liability layer. Many times dialogue with senior management reveals, after considerable inquiry, that such ventures have existed or exist with no protection. In a situation involving a multidivisional company, the broker assumed that full joint venture coverage existed at the primary and excess levels. However, the oil omnibus protection did not apply to non-oil exposures, and the umbrella exclusions concerning non-designated joint ventures had been obscured in the umbrella policy.

An endorsement regarding undesignated joint ventures is often accepted with provisions. These include addressing only the interest of the named insured, and then only on an excess basis, providing a self-insured retained limit agreeable to both parties and permitting the insurer to audit such exposures and get full prorata premium. In addition, the automatic nature of the protection may also be limited to a period of three or six months to the end of the policy period. Factors affecting employees and volunteers can create further misunderstandings. However, this hole may be the most important and, to the insured who pays the premium, the most dangerous.

Gaps Surrounding Limits and Exposures

When a company carries high liability limits it is assumed that protection continues without gap or change from the first dollar of coverage to the top layer of coverage. Unfortunately, that rarely occurs. Insurance companies contract with purchasers and basically have no obligation to other companies with coverage at levels above or below the policy being written. Additionally, companies have few direct responsibilities for cooperating with other insurance companies sharing the same level of liability. Consider the situation of a major oil company that purchased primary U.S. occurrence liability coverage with excess London claims-made protection. An analysis of how all layers meshed showed gaps and uninsured columns of liability. In a different scenario, a large development corporation had several insurers involved in the same general level of excess coverage. Not only did the companies disagree as to the responsibilities of the parties-the lead claimed to be prorata whereas the others claimed to be excess over the lead-but a more serious situation existed, resulting in the lead declaring bankruptcy.

There are many ways in which limits can prove incompatible. These occur when aggregate limits are applied and defined differently at different levels; primary and excess policies define key terms differently; policy periods, primary and excess, are not identical; following form requirements change at different levels; and exclusions take a variety of forms in excess layers of coverage from absolute to following form to removable.

What has been stated about limits applies equally to exposures. The mere listing of an entity on an excess policy, for example, does not guarantee the scope of protection. One oil conglomerate had more insureds at the umbrella coverage layer than the primary coverage level, but protection vanished because coverage to those insureds applied "only to the extent that protection existed at the primary level." Also, the insureds did not bring their primary exposures into the program, so naming the companies on the excess layer granted little coverage.

Exposures must also be considered from one policy period to another. When policies require insureds to report existing exposures as a condition for renewal, care must be taken in the identification and reporting process. This differs significantly from reporting expansion under a comprehensive liability form. Barring specific limitations, the insured is covered for new exposures during the policy period. However, if the exposure existed prior to the beginning of the policy period and was not reported, this condition may not apply.

Self-Insurance Problems

Self-insurance, while often a substitute for insurance may involve all the previously discussed problems and more, including the quandary of historical and prospective individual losses, loss reserves, changes in loss reserves and final payments. Other issues to address include the scope of the reporting process, which should take into consideration the number of losses, specifics of individual losses, updating and summaries; how well loss information is related to exposure information; and what knowledge exists about claim reserving practices, investigation requirements and payment authorizations. Finally, one additional problem unique to the self-insurance alternative is the safety of the funding methods and the provisions that exist for maintaining a fund sufficient to pay all claims for incidents which took or will take place during the self-insured period.

Another self-insurance matter involves how the protection conforms to corporate policy. Furthermore, one must consider how it relates to uninsured as opposed to self-insured areas and how it fits with primary or excess insurance. Mishandling these concerns may create an even larger black hole. For example, one city funded liability through a bond while it handled workers' compensation on a pay-as-you-go basis. However, the municipality had a loosely worded coverage document which incorrectly led officials to believe that the city's primary coverage was excess coverage.

In addition to the five major black holes, lesser ones exist, including variations between difference in conditions and unnamed perils; non-equivalence of Lloyd's, other British insurance companies and continental European insurers; the relationships between agreed amount, blanket and replacement cost coverage; and the variations in accident, claim and personal injury coverage.

Specific problems involving the definition of occurrence by industry type is typified by financial liability regarding different types of repossessed property, cooperative agreements between cities and counties, hospital medical staff exposures and proper coordination of coverage for onshore and offshore energy exposures. In addition, manufacturing and contracting relationships often change over time along with their definition.

Risk managers might also consider the following signals regarding insurance black holes. In the case of an entrepreneurial company, any time senior management or ownership decides to grow at an unusual rate, gaps in protection can exist. With a closely held company, there are few members of the senior management inner circle and financial reports are carefully guarded. If changes take place, the risk manager is often the last to know. He or she must find a way to provide regulation and risk assessment information as well as receive notice of major changes within the company.

In addition, incomplete identification of subsidiaries and locations may indicate a black hole, and unverified oral reports, insurance broker information or office memorandums should not be used by risk managers to identify exposures. Finally, poor policy documentation, audit information, certificate handling, contract approval and loss reporting are symptomatic of black holes.

The risk manager must be a scientist who identifies and redefines problems so they can be solved. When this is accomplished, the black holes regarding coverage, indemnification, the question of who is or should be insured, insured limits and self-insurance disappear.

Arthur E. Parry, Ph.D., CPCU, is manager of risk management services for The Wyatt Co. in Dallas.
COPYRIGHT 1990 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Author:Parry, Arthur E.
Publication:Risk Management
Date:Jun 1, 1990
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