FEATURE STORIES | MAY/JUNE 2008

Q&A on Insurance Coverage in a Slowing Economy

By Attorneys Paul Banker, Chris Lynch, Tom Mielenhausen, and Chris Yetka
Lindquist & Vennum, PLLP

As aware as we all are about the slowing of our economy, how the downturn can affect the myriad aspects of operating a business can be more ambiguous and sometimes overlooked. This month, we examine how insurance coverage and the claims process are affected when the market takes a dip.

How might a slowing economy affect the relationship I have with my insurance company?

Insurers make money by collecting premiums and investing the proceeds. Their profit is the return on their investment, reduced by expenses like claim payments. As returns on investments become smaller, pressure increases to reduce claim-payment expenses or spread them out over time. In a slowing economy, one can expect increased scrutiny of claims, with the result being that claims typically paid quickly in a robust market are likely to meet resistance in a slow one. In addition, the time-value of money dictates that certain claims paid during good times might well, in an economic downturn, be litigated with the goal of a discounted settlement, or to take advantage of the lengthy time required to resolve disputes in court. Expect increased claim scrutiny as insurers try to better manage their cash flow.

As a proactive measure, policyholders should maintain strong relationships with their insurance brokers, and if possible, their claims adjusters. Your broker and your insurer want to write coverage to bring in premiums, and with an established relationship to rely on, you may encounter a less hostile environment if you need to make a claim.

Will a softening economy provide any opportunities for policyholders? Is now a good time to review my coverage?

Like many other industries, the insurance industry experiences cycles of good and bad economic times. The insurance industry--like many segments of American industry--is currently in a "soft market" and will be for at least the immediate future. This means that demand has decreased and, as a result, competition among carriers for business has increased. For prudent risk managers in the market to purchase or expand insurance coverage, this may be an excellent time to reevaluate coverage pricing and options.

There can be benefits to purchasing or expanding coverage in a soft market. Because of a decrease in demand and a surplus of products, a soft insurance market generally means that insurers will lower their rates to attract business. Therefore, it is possible to secure existing or even higher levels of coverage at significantly reduced rates. In addition, insurers may develop new types of coverage programs to differentiate themselves from the competition, and the opportunity to obtain specialized coverage can be greater in a soft market than a hard market. In a soft market, insurers also tend to be less stringent with their underwriting standards, resulting in opportunities to obtain coverage generally not available during a hard market.

Prudent risk managers considering purchasing coverage in a soft market must weigh the disadvantages along with the benefits. Insurance companies desperate for business may issue coverage that will, in the long term, be expensive, either because the rates are too low or the risk insured against is too great. And those shiny "new" insurance products that looked so good at the outset can be fraught with uncertainty and more prone to coverage disputes down the line. It doesn't benefit your business to obtain bargain rates or expanded coverage if the insurer or policy you purchased isn't around when you need it.

For those in a position to purchase coverage in a soft economy, the market can yield excellent rates and increased coverage, but there are risks. Risk managers should thoroughly research each insurer's financial position, ask hard questions about what the insurer is doing to weather the soft market, and avoid being swayed by promises of low, low prices. While a soft market presents opportunities for obtaining expanded coverage at reduced rates, risk managers evaluating pricing and coverage options should be mindful of the adage "if a deal looks to good to be true, it probably is."

What steps can company directors and officers take to reduce the likelihood of economy-driven lawsuits brought by shareholders?

An increase in shareholder suits is inevitable during a downswing in the economy, even against well-run companies. However, directors and officers can take steps to ensure that their insurance programs are strong.

First, maintain sufficient limits in any applicable D&O policy. This is particularly important if you have a "wasting policy where limits are eroded by the payment of defense costs. Shareholder and employee lawsuits can be extremely expensive, and defense costs can quickly eat into amounts that could be used to pay any settlement or judgment. Further, the adequacy of limits is particularly important if the policy provides coverage to not only officers and directors, but also the company. Most insurers will offer additional limits of liability dedicated to executives.

Second, closely analyze any arbitration provisions in your policies. In package policies, some insuring agreements will include arbitration provisions. While those may make sense in the context of valuing losses, they can become hurdles for policyholders when the issue of coverage is at stake. For example, if a claim is brought by a shareholder asserting not only D&O claims, but also claims that may qualify for coverage under an employment-practices-liability provision, a policyholder may be forced to litigate coverage issues with the insurer in more than one forum. Further, insurers historically fare much better in arbitration than in court, and policyholder safeguards such as appeals and burdens of proof are often lost.

Third, put your insurer on notice of any claim, or potential claim, as quickly as possible. Insurers will universally assert late notice, or "known loss," if there is any hint that facts were withheld or notice was delayed. Have a program in place to analyze the likelihood of claims, and notify your insurer of claims immediately.

Finally, work with your insurance agent and broker to determine risks and analyze the completeness of your insurance program. Agents and brokers deal with claims every day and can serve as good evaluators of risk.

At what point in a potential claim situation should I begin talking with my coverage attorney?

You should consult with your coverage attorney as soon as you learn of a potential claim that may be covered under your insurance policy.

It's important to understand that, in any claims situation, insurers are potential adversaries until they unequivocally waive any and all rights to deny their duties under the insurance policy, including their duties to defend, to pay defense costs without recoupment, and to indemnify for settlements or judgments. This express waiver is rarely granted. Typically, insurers reserve the right to deny coverage on any and all grounds based on future developments and, in some jurisdictions, can remain silent about whether they are reserving rights.

This puts you and your business in a difficult situation, because an insurer might steer the investigation and development of a case in a way that fabricates support for fact-dependent coverage defenses, such as those based on the knowledge or intent of directors, officers, or employees; notice of claim or occurrence; purported misrepresentations in the insurance application; or apportionment of damages. In an effort to deny or diminish coverage, the insurer might use communications made by your company's employees in a way in which they were never intended to be used. The insurer might even try to obtain privileged or protected communications to which no adversary would be entitled.

Thus, it's wise to consult with your coverage attorney promptly. The attorney should be able to advise you about the potential coverage defenses associated with the claim, help you communicate carefully with the insurer, and assist you in protecting privileged information.

An ounce of preventative advice is worth a pound of litigation cure.

ABOUT LINDQUIST & VENNUM, PLLP

With offices in Minneapolis and Denver, Lindquist & Vennum's nearly 200 attorneys provide a full array of corporate finance, transactional and litigation services for corporate, governmental, and individual clients across the nation and around the world. For more information, visit www.lindquist.com.

This article is only a general summary for informational purposes and does not constitute legal advice. Consult a qualified and experienced insurance advisor for your specific situation or particular questions.

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May/June 2008