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ARTICLES
E & O POLICIES: ARE THEY REALLY PROTECTING YOU?
Since the economic downturn, broker/dealers and registered representatives are increasingly being accused of providing faulty investment advice to their clients. Most broker/dealers carry errors and omissions insurance to protect them from liability for such allegations. However, when it comes to catastrophic claims, insurance companies – much like investors – are asking broker/dealers and registered representatives to bear the brunt of a stressed market. Financial organizations are well advised to take stock of their errors and omissions policies and have a frank discussion with their insurance agents to ensure that if and when claims arise, the organization, its representatives and control persons are adequately covered.
Claim and Aggregate Limits
As with all insurance policies, errors and omissions insurance policies contain defined limits to coverage. First, most policies have a limit on the amount of funds that will be paid out to defend against and settle a single claim, known as the “claim limit.” Likewise, the same policies have a limit on the total amount of funds that will be paid out to defend against and settle all claims made against the broker/dealer within the policy period, known as the “aggregate limit.”
As a result, if an insurance policy has a $500,000.00 claim limit and a $2.5 Million aggregate limit, the insurance company will only allocate $500,000.00 to the defense or settlement of a single claim, and a total of $2.5 Million to the defense or settlement of all of the claims made within the policy period, even if more than five claims are made during that time (five claims x $500,000.00 limit per claim = $2.5 Million aggregate limit).
Unfortunately such claim and aggregate limits are often insufficient to defend against and settle claims made against broker/dealers in these troubled financial times – especially when the true basis of loss was simply market conditions.
Insurance Companies Redefining Terms
Although the language of most insurance policies seems clear, insurance carriers hamper a broker/dealer’s ability to obtain the insurance coverage to which it is entitled by redefining the terms of their insurance policies. As each policy and situation is different, understanding your policy before an issue occurs is important.
For example, if 20 investors made separate claims against the same broker/dealer for the sale of the same product to all 20 investors for a total investment amount of $10 Million, the carrier may consider all 20 investors as one claim with a claim limit of only $500,000.00 to defend against or settle with the investors. On many occasions, the carrier takes this position despite requiring the broker/dealer to pay 20 separate deductibles (also known as retentions) for each of the 20 claims.
As a result, the insurance company may only allocate $500,000.00 to the defense against and settlement of the claims made by the 20 investors, while requiring the broker/dealer to pay $500,000.00 (i.e., $25,000.00 per deductible x 20) for the allocation of said funds. Under this theory, the broker/dealer will have paid significant premiums over the policy period for essentially no coverage under its insurance policy.
Under the law of many states, such conduct could be considered bad faith by the insurance companies. For example, some states not only allow the broker/dealer to recover the full amount allowed under the policy, but also allow for the recovery of punitive or excess special damages of various amounts. Likewise, states may allow for the recovery of attorneys’ fees paid by a broker/dealer for the recovery of damages from an insurance company acting in bad faith. Below are several questions that should be addressed with your carrier:
Is the carrier allowing the insured to have say in the appointment of defense counsel?
Has the carrier’s reservation of rights letter included a statement about claim limits?
Has the carrier stated that there is only one retention required for claims made by multiple investors on the same security or financial product?
If a carrier refuses to comply with the clear language of its insurance policy, thereby hampering the ability of a broker/dealer to defend against and resolve claims, it is essential that the broker/dealer be fully advised of its rights. Speak with an attorney well versed in insurance coverage disputes, one who has a business background and is cognizant of the impact of claim/aggregate limits on the broker/dealer’s unmade claims.
In addition, research other similar situations involving the carrier to see if there is any inconsistency in the carrier’s position regarding claim/aggregate limits. Abuse by insurance companies should not be tolerated by the financial services industry.
As always, the best solution is prevention. When shopping policies, it is important to not only involve your insurance agent in finding adequate and cost-appropriate policies, but it is also well worth the investment in employing an attorney to review the competing policies in light of the current and anticipated business climate and possible claims.