There’s a world of difference between an insurer being able to take action solely at its option vs. having to negotiate a claim in good faith. Arranging the right insurance policy language up front is the key to making this happen.
Let’s look at three examples in commercial property/casualty insurance policies where seemingly small distinctions become hugely important later, at claim time.
Representation vs. Warranty
Always be on the lookout for the words “warranty” or “warranted” in an insurance policy. A warranty given by the insured is interpreted so strictly that a violation of it can strip the insured of coverage even if a breach is not material to an insurance claim.
For example, a company might represent that its construction project will be fenced and lighted. If the company fails to do so, and then its project is subject to hurricane damage, obviously unrelated to the fencing or lighting, it should be fine, at least on that specific claim.
On the other hand, if the policy contains a warranty with respect to such two conditions, a insurance claim could well be in jeopardy, notwithstanding the fact that the claim was not related to the breach in any way.
Lloyd’s of London and other U.K. insurers are overly fond of using warranties in their policies, so be on the lookout with those insurers especially. Warranties are used by U.S. insurers as well, but sparingly. Overall, try to avoid warranties.
Absolute Answers on an Application
Insurance applications can be minefields. Never lie on an application. Sometimes, however, the questions are worded so ambiguously that it’s hard to tell exactly how to answer them, which might lead to the applicant opting for the least conservative answer. This happens frequently with questions to which the only answer options are “yes” and “no.”
In a recent cyber insurance case, the following question came to bite the insured in a big way:
Question: “Do you replace factory default settings to ensure information security systems are securely configured?”
Questions like this can never be answer with an absolute yes. Basically, it’s a promise that can’t be kept. If company had not taken the promised action the one time it experiences a loss, it would likely be accused of a misrepresentation, putting coverage in harm’s way.
One way to respond to the question is not checking either “yes” or “no” but rather writing in, “It is our procedure to do so whenever possible.”
Saying yes leaves no room for error. Saying no is riskless but inaccurately implies a lack of care. The written-in answer establishes the right middle ground to provide room to maneuver. Our position in the insurance claim setting would be, “We do have the procedure, and here’s a copy of it, but we failed to execute this one time.”
Permission to Settle
A company may be sued by a party claiming the company injured them. Companies have liability insurance for these cases. Sometimes such claims may not be legitimate, but the insurer wants to settle them anyway.
While a settlement might be financially prudent for the insurer, it’s not necessarily the right move for the company. An unwarranted settlement affects the company’s claims record and reputation, and it might generate copycat claims. Therefore, the company wants to have some say in the matter. Let’s see how to get some room to maneuver in these cases:
General Liability: The policy gives the insurer strong grounds:
“We may, at our discretion, settle any claim….”
That pretty clearly provides little room to maneuver. The GL is a tough one, but we have argued in important cases that the policy also gives this to the insured:
“We will have the duty to defend the insured….”
Do these two clauses contradict each other? I don’t know that the point has been debated in any court, but the argument does provide some room to maneuver.
Directors & Officers (D&O) Liability and Professional Liability: With this type of insurance, where reputation is more important, policies give the insured more freedom to influence the settlement. Be aware of the following options when shopping for a policy.
Here is one of the best consent clauses: “The insurer may, with the written consent of the insured, settle any claim for a monetary amount that the insurer deems reasonable.”
That clearly requires the insured’s consent to a settlement; if consent is denied, the insurer cannot settle and must defend.
In many large cases the insured is in control of the defense, with the insurer paying the bill. The policy would say: “The insureds will not enter into any settlement agreement without the insurer’s prior written consent.”
There is a key clause to be added: “The insurer’s consent will not be unreasonably withheld.”
With the right competition-generated leverage, these terms can be negotiated at the time of policy purchase. At that time, underwriter concern can be managed.
But after a loss, all bets are off, as the insurer undergoes an attitude adjustment. You can be sure that any clause in the insurer’s favor is likely to be construed to the letter in the claim settlement process.
Be street-smart: know what’s in your policy and be proactive. A one-way contract negotiation is never going to end well. (Click here for a general discussion of policy language negotiation.)
Frank Licata is president of Licata Risk Advisors, a Boston-area risk management consulting firm.