E&O Insurance. Welcome!

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1 Welcome! Welcome! This course was designed to provide accurate credit hours for your state. It is not intended to be used as selling material, in part or whole, or to give any type of legal advice. Since this material is gathered from multiple sources, there may be differences of opinion stated or implied. In addition, laws and customs do change, so it is important to realize that facts and figures herein may also change. It is understood by those who read this course for their credit hours that we expect each agent to be ethical in their dealings with us. This means that each agent must complete their own test without any help from another person or entity. We expect each agent to follow the guidelines of their state. All courses are solely owned by No portion of the book may be copied or used for any other purpose than the one we intended: credit hours through Thank you, nd Street East Eatonville, WA (253) Welcome!

2 Table of Contents Table of Contents: Chapter 1: Liability Dangers Public Awareness: Page 1 Classified as a professional 2 Malpractice Insurance Policies 4 Standard of Care 5 In Summary 9 Chapter 2: General Liability Industry Variety 10 Insurance Agents 11 Insurance Agents Professional Negligence 12 Insurance Agents Presumed Negligence 13 Insurance Agents Contributory Negligence 14 Insurance Agents Imputed Negligence 14 Insurance Agents Negligence in Tort Liability 15 Express Authority & Ostensible Authority 17 Torts & the Basis for Liability Claims 19 Torts & Contracts 20 Liability Under Torts 20 Insurance Agents Civil & Criminal Violations 20 Insurance Agents Breach of Contract 22 Breach of an Implied Agreement Theory 23 Breach of Contract Theory 23 Legally Binding Insurance Contract 23 Relevance 24 A Contract of Adhesion 24 For Review: 25 Accountant s Liabilities 25 When Are Accountant s Not Liable to Third Parties? 26 Accountant Negligence 28 Accountant Breach of Contract 29 Accountants Civil & Criminal Violations 30 Investment Advisor s Liabilities 30 Stockbroker s Liability 32 Stockbroker Negligence 33 Stockbroker Breach of Contract 34 For Review: 36 Table of Contents

3 Table of Contents Chapter 3: Preventive Measures Public Harm 37 Triggers 37 Financial Planning in the Real World (risk) 38 The Degree of Risk 42 Inflation 42 Likelihood of Loss 45 Degree of Loss 46 Risk Classifications 47 Who Should Carry the Burden of Risk? 49 What Type of Documentation? 51 Claiming Unearned Education or Experience 51 Full Disclosure 52 Release of Liability Form 52 What Is Due Diligence? 54 Fiduciary Duties 55 Keeping Current on New Trends 56 Chapter 4: The Policy By Any Other Name Claims-made & Occurrence policies 60 Insurance Agents 63 Financial Planners 64 Chapter 5: Professional Ethics Industry Ethics 65 Personal Ethics 66 What Are Ethics? 66 Virtues 68 What Motivates Ethical Behavior? 70 Egoists 73 What Are Our Responsibilities to Other Moral Persons? 79 Establishing Our Identity 80 Objectivist Ethics 81 How Can One Be Ethically Active? 82 Laws and Ethics nd Street East Eatonville, WA Table of Contents

4 Liability Dangers Chapter 1 Liability Dangers Public Awareness More and more people today have become increasingly aware of their legal rights. There are many reasons for this increased awareness. For one thing, there are more articles published in newspapers, magazines and periodicals about common legal problems a person may face. In addition, there are television programs dealing with many legal issues. To add to this we have lawyers advertising their services. The result of this available information is somewhat knowledgeable consumers who are more likely to sue someone if their service or product does not fulfill the consumer's expectations. Many of today's consumers are ready to go to court at the slightest dissatisfaction resulting in a number of groundless and frivolous lawsuits. We could say this is a negative result of increased knowledge and even term it as a "sue happy" society. Even so, there is a positive side of increased public awareness. This willingness to sue when dissatisfied is good since the so-called "little man" is no longer being intimidated. Professionals often feel that they do such a good job that they are immune from the threat of lawsuits, but that certainly is not the case. The 1970s saw the beginning of the trend to sue professionals for negligence or malpractice. The definition of a professional was broadened in the 1970s to include not only doctors and lawyers, but also architects, engineers, accountants, stockbrokers and insurance agents. It also expanded the definition to include such diverse groups as real estate agents, management consultants, crop dusters, data processors, printers, employment counselors, translators and telephone answering services. In this text, we will refer to all of the above professions as "professionals." Chapter 1, Page 1

5 Liability Dangers The 1970,s saw the definition of professional broadened to include accountants, stockbrokers and insurance agents, among others. Perhaps the newest professional field to be classified as a profession is that of financial planning. Along with the benefits of being recognized as a profession comes the burden of stricter standards of conduct. This also increases the chances of being sued for malpractice. If the financial planner performs poorly in the mind of his or her client, a lawsuit can definitely result. This makes the financial planner especially susceptible since views of good and poor performance are often hard to verify. Clients are very skeptical about any loss of money regardless of whether or not the financial planner acted in good faith. The financial planning industry, on the whole, has very few guidelines for avoiding malpractice suits. We would hope that all financial planners have a code of ethics, of course. Being personally ethical, however, is not guaranteed protection. There are various organizations, such as the International Association for Financial Planning (IAFP) and the for Certified Financial Planners Board (formerly IBCFP), that have published codes for financial planners to follow. In fact, the CFP Board has continuing education requirements for their agents, specifically requiring two hours in an approved course dealing with their Code of Ethics and Standards of Practice of the International Board of Standards and Practices for Certified Financial Planners. The individual codes published by these organizations provide ethical guidelines, not rules of law. Lawyers have been guided by years of numerous legal cases to which they can refer in order to help determine a course of action along with their detailed code of ethics. The longer the financial planning industry exists, the more guidelines the financial planner will have in terms of more case law, established precedents and definitive regulations. Initially only a few states required ethics as part of their continuing education requirements but that is no longer true. Currently the majority of states require some type of ethics as part of the total continuing education requirement. Requiring ethics as part of the total CE requirement does not mean the insurance departments believe their agents are unethical; rather it is an attempt to emphasis the importance of ethical behavior. Chapter 1, Page 2

6 Liability Dangers Even without established legal precedents and definitive regulations, it is still possible for a financial planner to take affirmative measures to avoid a malpractice suit. The most obvious and important key is awareness. Through this awareness, an insurance agent or financial planner can achieve a set of standards by looking at the standards of care required by other professionals, particularly those professionals who comprise the majority of the financial planners today. These would include insurance agents, insurance brokers, accountants and stockbrokers. Since the financial planner s duties often include many of the responsibilities of these professionals, looking at how the courts have treated their cases can be helpful. The most obvious and important key is awareness. This acquired awareness would also include understanding and knowing the duties of a financial planner. A financial planner seldom wears one hat. Rather he or she is also an insurance agent, a tax advisor, a retirement advisor, and an estate planner. The financial planner must always be conscience of what role they are currently playing in order to avoid any potential conflicts of interest. For instance, an insurance agent/financial planner has to be careful not to recommend excessive life insurance. If his or her recommendations appear excessive or inappropriate it could be viewed as self-serving (to obtain excessive commissions, for example). On the other hand, if too little insurance is recommended, this could be considered negligence. At all times, it is important for the insurance agent/financial planner to document why such recommendations have been made. These documentations should be dated and kept in the client s file. In past years we have also seen a rise in the number of larger judgments being awarded to plaintiffs who brought suit against professionals. Not only were courts awarding judgments in excess of the professional's insurance policy limits, but punitive damages were being awarded as well. Normally the courts motivation behind punitive damage awards is to punish the wrongdoer. It is questionable whether punitive damages can be paid out of an insurance policy's fund. However, since punitive damages are awarded only in cases where punishment is required, a financial planner has hope of avoiding this if he or she tries to adhere to industry guidelines and does not intentionally do anything illegal or improper. As stated, documentation of all financial recommendations is extremely important. Chapter 1, Page 3

7 Liability Dangers Many financial planners believe they will be sued for malpractice at least once in their professional career. Therefore, two issues must be addressed: 1. What can a financial planner do to try to avoid a malpractice suit? 2. What should a financial planner do to mitigate the harm of a malpractice suit if one is filed? If a malpractice suit is filed, it does not necessarily matter whether or not the professional is found innocent. The harm to the professional is simply the filing of the suit and the publicity that nearly always comes with it. Many people may know of the malpractice suit and yet not many will know if the professional is found innocent. Damage to the professional's reputation has occurred. To add injury to insult, it is a time-consuming process to be involved in a malpractice suit. During that time, the professional may lose clients simply because they are the target of such a lawsuit. The numerous hours spent in court and giving dispositions will take the professional away from work and result in further decrease in productivity and thus, income. Of course, there will be legal fees as well. With typical professional liability insurance, the insurer cannot settle a claim without the insured's consent. Malpractice insurance policies also referred to as Errors and Omissions insurance or E&O insurance will be discussed in a later chapter, but it needs to be mentioned because this type of policy contains a unique settlement clause in favor of the insured. With typical professional liability insurance, the insurer (insurance company) cannot settle a claim without the insured's consent. In typical property and casualty insurance policies, the insurer is given the right to settle the claim in whatever fashion they feel is reasonable. Because the professional's reputation is involved it is important that a suit not be settled if it lends further damage to the individual s future. Any settlements made on behalf of the professional could be construed as an admission of guilt. Even with this provision, however, the majority of claims against professionals are settled rather than taken to court. This is true because of the time and expense involved in litigation, the adverse publicity that accompanies a lawsuit and the negative Chapter 1, Page 4

8 Liability Dangers effect the suit can have on the professional's practice. Many professionals opt to settle a claim against them, whether it is valid or not, rather than experience the above stated consequences. Standard of Care One of the first steps to avoiding a professional liability lawsuit is to understand what is required of a professional when dealing with a client. In legal terminology, the professional should know the applicable standard of care owed to a client. A claim based on liability imposed by law develops as the result of the invasion of the rights of others. A legal right is more than a mere moral obligation of one person to another, for it has the backing of the law to enforce that right. Legal rights impose many specific responsibilities and obligations. Some of these are quite obvious in a general sense, such as not invading the privacy or property of others or not creating an unreasonable risk or actual harm to others. The invasion of legal rights is a legal wrong. The wrong may be: 1. criminal (public), or 2. civil (private). A criminal wrong is an injury involving the public at large and is punishable by the government. The action on the part of the government to effect a conviction and impose fines or imprisonment is termed a criminal action. Negligence is an example of a tort. Chapter 1, Page 5

9 Liability Dangers Civil wrongs are based upon: 1. torts, and 2. contracts. Torts are wrongs independent of contract. Examples of these would include false imprisonment, assault, fraud, libel, slander and negligence. Contracts may involve legal wrongs when applied to warranties which are violated, bailee responsibilities which are not fulfilled or contract obligations which are breached. For liability insurance, the emphasis is on civil wrongs and particularly on the many legal wrongs based upon torts. Of the greatest importance are torts resulting from negligence (unintentional acts or omissions). Negligence is the failure to exercise the proper degree or standard of care required by circumstances. Torts include all civil wrongs not based on contracts. As such, they are a broad residual classification of many private wrongs against another person or organization. They occur independently of contractual obligations and may result from: 1. intentional acts or omissions, 2. strict liability imposed by statute law, or 3. negligence. Chapter 1, Page 6

10 Liability Dangers We are going to concentrate on the negligence portion. Negligence is a tort; a civil wrong not based on a contract. Most of the liability imposed by law stems from accidents attributable to negligence. If negligence can be shown to be the proximate cause of an injury or loss to another, the negligent party is liable to the injured party for damages. Negligence is the failure to exercise the proper degree or standard of care required by circumstances. It may consist of not doing what is required under the circumstances, or doing something that ought not have to have been done. Behavior in any circumstance which fails to measure up to that expected of a careful, prudent person in like circumstances constitutes negligence. Faulty judgment may result in liability for negligence, even though the motive behind the act was the best. Behavior in any circumstance which fails to measure up to that expected of a careful, prudent person in like circumstances constitutes negligence. In an ordinary negligence case (not involving a professional), the standard of care required of the defendant pivots on the questions of whether or not the accused behaved as "an ordinary reasonable prudent person" would have behaved under similar circumstances. In addition, the defendant is required to use any special knowledge they may have obtained through education, training, or experience. This obviously affects insurance agents, since they have received special training and education and probably have some type of experience as well. In regards to the professional, the required standard of care changes. If a person offers professional service to the public, it is presumed that the person possesses some degree of special skill and knowledge. Unlike the ordinary negligence cases, where special skill and knowledge is considered only if the accused in fact possesses it, a professional negligence case imposes a certain level of skill and knowledge on the defendant whether or not they actually possess that skill or knowledge. Anytime an individual displays any assumption of professional skill, it is assumed to be real. This would include such things as having business cards printed which read financial planning. Having such cards printed indicates training, education, or experience. It does not matter whether or not the individual actually has any training, education or experience. It will be assumed that he does. It is the learning and skill ordinarily exercised by members of the particular Chapter 1, Page 7

11 Liability Dangers profession stated. Since this standard of care applies to the profession stated on the business card, in a lawsuit the individual will be expected to have performed to the level of that profession. That is why it can be very dangerous to allow clients to assume training, education, or experience that does not actually exist. Since just about anyone can claim to be a financial planner, it may hard for the average person to know if one is qualified or not. There has been much attention given to this matter by individual states requiring specific knowledge of those who profess to be financial planners. However, with the development of the IBCFP and IAFP's Registry, along with the movements by individual states, this is changing. With increased regulation of the financial planning industry, the states are attempting to clarify who can and who cannot make such claims. The lawsuits against financial planners will likely increase as well, encouraging the establishment of legal precedents. Attorneys now have the option of attending classes on how to sue insurance agents and financial planners. It is something that every agent should consider before stepping into dangerous situations. Chapter 1, Page 8

12 Liability Dangers In Summary The definition of a professional was broadened in the 1970s to include not only doctors and lawyers, but also architects, engineers, accountants, stockbrokers and insurance agents. Malpractice insurance also referred to as Error and Omissions insurance or E&O insurance are a type of policy which contains a unique settlement clause in favor of the insured. It does not allow the insurer to settle a claim without the insured's consent. Torts are wrongs independent of contract. Negligence is a tort, a civil wrong not based on a contract. Negligence is the failure to exercise the proper degree or standard of care required by circumstances. A professional negligence case imposes a certain level of skill and knowledge on the defendant whether they actually possess that skill or knowledge. This is a standard of minimum professionally acceptable conduct. Chapter 1, Page 9

13 General Liability Chapter 2 General Liability Industry Variety The financial planning industry has one characteristic that is unique to this industry: its members come from a variety of other industries. Financial planners can be accountants, stock brokers, or insurance agents. It may be possible to predict the future treatment in the professional liability field by looking at the treatment of these various professions. We have also seen the banking industry go into the financial planning field, as well as other industries not otherwise considered a financial planning field. This chapter will primarily focus of the three professions from which the majority of financial planners come. This would include insurance agents, accountants, and stockbrokers. The financial planner s duties often include many of the duties of these professionals. Looking at how the courts have treated these professionals can help us determine how the financial planning field will be treated by the courts. It is particularly relevant since the duties of an insurance agent, for instance, parallels those of a financial planner - preparing and analyzing financial statements, determining risk exposures, determining adequate insurance amounts, investing the client s money, and planning the client s retirement and estate planning needs. In recent years we have also seen cases establishing a standard of care for investment advisors. Certainly financial planners would fall into the category of investment advisors, as do some insurance agents. Looking at these cases also offers a means of predicting how a financial planner will be treated in court. Chapter 2, Page 10

14 General Liability Insurance Agents Insurance agents are in the ranks of other professionals in the quest for risk avoidance, which means that liability insurance is a must. Physicians have had to pay plenty over the last years for professional liability insurance. Attorneys joined physicians as liability risks, followed by accountants, then insurance agents and financial planners. Insurance agents are further faced with limited liability insurance coverage and increasing premiums. Add to this the national awareness about potential liability risks, making clients more apt to litigate in the event of a mistake on the part of the insurance agent. It is safe to say that liability insurance is a necessary part of doing business for insurance agents, just as it is for physicians and attorneys. As we stated, there could be a conflict of interest for an insurance agent who is also a financial planner. The two roles need to be separately maintained to some degree. Of course, all industries who deal with finances must consider how the various roles interact. The insurance agent who is also a financial planner will want to market their services, but each type of service must be correctly handled. The ethical standard in these circumstances must always consider the client first and commissions second. We could use the example of a young family, both parents are age 26, with one child, age three, who comes to an insurance agent/financial planner wanting life insurance. It is determined that the family needs at least $250,000 life insurance coverage. However, the family cannot afford the cost of a whole life policy. Should the insurance agent sell them less insurance coverage and receive higher commissions? Or should the agent sell the family a less expensive term policy covering the family the way the financial planner saw fit? Naturally this potential conflict of interest exists for the insurance agent who is not a financial planner, but the problem seems to increase in severity Liability of Agents What an agents says in terms of puffing or exclaiming the virtue of a policy is often not actionable except in the circumstances where an agent assumes additional duties, has a special relationship of trust with the buyer, or holds himself/herself out as having special expertise. Then a special duty arises. But when an insurance agent gives assurance of proper coverage and it turns out to be false, that agent will be held liable for negligent misrepresentation. That is not to say that an insured can remain intentionally ignorant of the terms of a policy. An insured is not required to independently verify the accuracy of representation made by the agent regarding the policy and an agent can be held liable for intentional or negligent misrepresentation. - Richard Alexander, Esq. Chapter 2, Page 11

15 General Liability for the agent who is also a financial planner since their primary function is not to sell a product but to provide financial advice. Some industry people feel consumers should seek out a financial planner that does not sell products of any kind; they merely advise consumers. Insurance Agents Professional Negligence Conflict of interest is one of many professional liability problems facing insurance agents or brokers. They, like other professionals, can be found liable for negligence, violation of a statute, and breach of contract. Negligence is the broadest field of exposure for an insurance agent. Negligence is the broadest field of exposure for an insurance agent. Negligence is a tort - a civil wrong not based on a contract. Negligence is often the result of carelessness, thoughtlessness, forgetfulness, ignorance, or just plain stupidity. It involves errors and omissions made by the insurance agent. The majority of the liability imposed by laws stem from accidents derived from negligence. If negligence can be shown to be the proximate cause of an injury to another, the negligent party is libel for the injuries or damages sustained. We tend to think of negligence and damage to others to be physical, but financial damage is also possible. Negligence could be defined as the failure to exercise the proper standard of care required by the circumstances. Negligence never involves intent. A negligent act may include not doing what was required under the circumstances, or doing something that fails to measure up to what would be expected of a prudent person in like circumstances. Faulty judgment may result in liability negligence, even though the motive behind the act was purely innocent. This point is very important when it comes to anything financial. A financial loss does not necessarily mean faulty judgment; no one has a crystal ball when it comes to investing. However, if the advice given is indeed found to be faulty, then a malpractice lawsuit is possible. Chapter 2, Page 12

16 General Liability There are laws that require all persons to use prudence in their actions so that others will not suffer bodily injury or property damage. Failure to heed such prudence gives the injured party a right to action against the negligent party for damages. Prudent behavior is based upon what society expects of the individual. The conduct must be reasonable in light of the risk involved. Insurance Agent s Presumed Negligence Ordinarily the burden of proof lies on the plaintiff (claimant) in a negligence case. The plaintiff must prove that the defendant failed to exercise the reasonable standard of care for a prudent person. However, this may not always be the case. If the facts presented justify a reasonable form of judgment of negligence, the courts may lift the burden of proof requirement by applying the common law doctrine of res ipsa loquitor (meaning the thing speaks for itself). Negligence is presumed without the plaintiff having to prove it. The burden of proof is then shifted to the defendant. Under this law a legally sufficient case of negligence can be established and referred to the jury if the: plaintiff s injury was caused by a defective object, injury could not have occurred without the defendant s negligence, and object causing the injury was controlled by the defendant. These conditions establish presumed negligence. The law of presumed negligence applies when an accident causes an injury preventable by the use of prudent care and/or safety inspections. Presumed negligence has been applied to a number of accidents which occurred without witnesses: railroad or aviation injuries, medical malpractice claims, and/or damages from defective products for example. The last example of product liability has some difficulty applying res ipsa loquitor in the courts. That is because the claimant, not the defendant, controls the product. The control of the product lies in how it was used: properly or improperly. However, the courts have held defendants in control of the product if it has not been changed since leaving the manufacturer. The courts are not consistent with these decisions, though. Chapter 2, Page 13

17 General Liability Insurance Agent s Contributory Negligence When negligence is presumed, the plaintiff must not be guilty of contributory negligence. The circumstances of the accident must be unquestionable as to the negligence. If the accident could be caused by any other means the res ipsa loquitor law is not applicable. Presumed negligence does not exist if the accident results from circumstances beyond the control of the defendant. The accident must be such that the injury could not have occurred ordinarily without the negligence of the defendant. An accident resulting from a third person s involvement or from any physical or mechanical action is also not applicable. Insurance Agent s Imputed Negligence Imputed negligence makes an individual responsible for negligent acts of others. Employers may be liable for the action or negligence of their employees, as well as the employees themselves. If an employer uses independent contractors whose employee negligently causes an injury, that employer could be held liable if it provides faulty instructions or tools. Imputed negligence can occur even to unaware individuals. Landlords whose tenants cause an injury from a negligent act could be held liable. Parents could be held liable for the actions of their children. Vicarious liability laws impute liability to automobile owners even though they are not driving or even riding in their cars. Even if the car was borrowed by a friend, the owners of the vehicle could still be liable for the actions of the driver. Under the family purpose doctrine liability applies particularly to the automobile owner whose family members negligently use the car. Although presumed negligence may not apply if a third person is involved in the negligent act, imputed negligence does apply to third persons who may not be directly involved. Chapter 2, Page 14

18 General Liability Insurance Agent s Negligence in Tort Liability Where allegations of negligence are made, lawsuits present major issues in tort liability. There are typically specific things which must apply: 1. Before a court will award damages for negligent liability to a plaintiff, four requirements must exist. They are: a) a legal duty to protect the injured party, b) a breach of that duty or wrong, c) an injury or damage to the plaintiff s person, property, legal rights or reputation, and d) a reasonably close proximate relationship between the breach of duty and the plaintiff s injury. 2. Defenses in a negligent action. Since there are never absolutes, a plaintiff may prove all four elements (legal duty, breach of duty, the injury and proximate relationship) of a negligent act and still not be awarded damages. The defendant has several successful defenses available. Two principal ones are: a. contributory negligence, and b. assumption of risk. Contributory negligence means that the plaintiff is also negligent and that negligent action contributed to the loss incurred. If the plaintiff is guilty of contributory negligence, they may be denied damages. Contributory does not relieve the defendant of duty to the plaintiff. Instead, it denies the award of damages to the plaintiff if both parties are at fault. In a strict sense, the doctrine of contributory negligence does not always produce equitable results. A slight degree of responsibility, (negligence) on the part of the plaintiff could result in no award of damages. There are two substantial variations of contributory negligence rules: Chapter 2, Page 15

19 General Liability a) comparative negligence, and b) last clear chance. Under comparative negligence, the court, often the jury, attempts to scale or diminish in proportions the awards according to the comparative degrees of negligence of the parties involved. Not all states have comparative laws. Partial comparative negligence statutes are more common. Under the last clear chance doctrine, the defendant is able to prove that the plaintiff had the last clear chance to avoid the accident. The last clear change doctrine states that the defendant with the last clear chance to avoid the accident is guilty of contributory negligence by failing to avoid the accident. If both the plaintiff and defendant were inattentive, this doctrine does not apply. 3. Statutory modifications of the common law on negligence. The most common type of negligence for insurance agents is failure to place necessary insurance, failure to obtain proper coverage, failure to properly advise of the company s rejection or lack or coverage, failure to cancel a policy at the insurer s request, and failure to fully disclose the nature of the risk. In addition to this, the agent may be liable for giving unauthorized instruction to insureds or unauthorized interpretations of coverage, delaying the underwriting or claim information, or binding an unacceptable risk. We can look at some examples of an agent protecting themselves from a liability claim by informing the client of their options completely. Many property and casualty agents are expected to mention the availability of umbrella liability insurance when they are selling an auto or homeowners policy. This is not done for the purpose of receiving higher commissions. Umbrella liability policies do not offer the agent particularly large commissions. The agent who does this is doing it to protect themselves in the event that the insured suffers a loss greater than the amount of liability protection provided under the auto or homeowners policy. By informing their clients of the option of buying more liability coverage, the agent is preventing the insured from filing a suit against them for failing to provide adequate coverage. Of course, this insurance offer should be documented, perhaps even obtaining a reject signature from the consumer. Chapter 2, Page 16

20 General Liability Another example of an agent protecting themselves from lawsuit is the practice of giving complete information. For example, the insurance agent who informs the policyholder of the minimum insurance coverage required by the state, but, given the client s assets, suggests a larger amount of coverage as appropriate. The client then has the option of declining the additional coverage, thereby, releasing the agent of a negligent act. The agent should then document that the coverage had been discussed and refused by the client. The agent may go as far as having the client sign a form acknowledging this denial of additional coverage. In this way, the client will not be able to claim that the agent failed to offer the adequate coverage needed. Insurance agents and brokers can be held liable for a vast array of actions. It should be noted that they can be liable to both the client and to the insurer for which they work. We should also make a distinction between agents and brokers. Agents are considered representatives of the insurer. Brokers are considered representatives of the insured. The broker s primary allegiance is to the client. Knowledge of the broker is not considered to be knowledge of the insurer. The agent and the insurer are deemed to have the same knowledge. Express Authority & Ostensible Authority Identifying the distinction of knowledge could be critical if an insured chose to sue both the agent or broker and the insurance company. Normally, if the broker is involved the insurance company can escape liability. As with anything, there are always exceptions. Sometimes when dealing with the agent, the insurer can still be held liable even if the agent oversteps their express authority. Express authority refers to the powers given to the agent in the agency agreement or contract. In addition, the agent also has certain implied powers. The courts have used the doctrine of ostensible authority to give agents those powers the public reasonably expects them to have. An example of liability would be that of a life insurance agent who accepted the premium for a life insurance contract with a company for which he was not contracted. The insurer had not given the insurance agent the authority to accept the premium. The insurer could be bound since it is reasonable for the public to believe that an agent has the authority to accept premiums. Chapter 2, Page 17

21 General Liability Another example where ostensible authority can be invoked is when an agent is told by the insurer that the company will not write homeowners coverage on homes over 50 years old. Assuming the agent writes a policy on a home over 50 years old, the insurer could still be liable to the insured if any claims arose since there would be no reason for the insured to know the issuance of such policies was forbidden. Of course, in these situations, the insurer may have recourse against the agent for the actions they took. In many situations, the agent/broker distinction can become less critical. Instead, the actual facts of the situation will be looked at to determine whom the agent or broker was representing: 1. the insured, or 2. the insurer. In any case, the agent or broker must and is expected to act with reasonable care and diligence when representing the insured or insurer. Another aspect to look at is how the courts view the insurance agent. Assuming the court views the insurance agent as a professional, the applicable standard of care would be that of the skill and expertise of the average professional in that industry. We all know, of course, that some agents are more expert than others. Those who overstep the bounds of common sense cause the entire industry to experience change, as states legislate to protect the consumers. We can look at court cases that discuss the implied law duty of good faith and fair dealing that is imposed on agents and insurance companies. In the case of Fletcher v. Western National Life Insurance Company, the court stated: We think that, similarly, the implied-in-law duty of good faith and fair dealing imposes upon an insurer a duty not to threaten to withhold or actually withhold payments maliciously and without probable cause, for the purpose of injuring its insured by depriving him of the benefits of the policy. In a similar court case, United States Fidelity and Guaranty Company v. Peterson, it also mentions this same standard of care: Chapter 2, Page 18

22 General Liability Where an insurer fails to deal fairly and in good faith with its insured by refusing without proper cause to compensate its insured for a loss covered by the policy such conduct may give rise to a cause in action in tort for breach of an implied covenant of good faith and fair dealing. The duty violated arises not from the terms of the insurance contract but is a duty imposed by laws, the violation of which is a tort. The courts here are referring to insurers in speaking of the duty of good faith and fair dealing, but it is also applicable to the insurance agent. Typically, if the insurance company is sued for bad faith, the agent will also be named as a defendant. Torts & the Basis for Liability Claims Question: What is the legal basis for a liability claim? Answer: A claim that is based on a liability imposed by law which develops as the result of the invasion of the rights of others. This legal right is more than a moral obligation of one person to another. This legal right has the backing of the law. Legal rights impose many specific responsibilities and obligations. The invasion of such legal rights is deemed a legal wrong. The legal wrong may be: 1. criminal (public), or 2. civil (private). A criminal wrong is an injury involving the public at large and is punishable by the government. The action on the part of the government to effect a conviction and impose fines or imprisonment is termed a criminal action. A civil wrong is based upon two things: 1. torts, and 2. contracts. Chapter 2, Page 19

23 General Liability Torts & Contracts Torts are wrongs independent of contract wrongs. In other words, they involve actions of the agent or others but not the contract. This includes false imprisonment, malicious prosecution, trespass, conversion, battery, assaults, defamation (libel and/or slander), fraud, and negligence. Contracts may involve legal wrongs when implied warranties are violated or contract obligations are breached. Liability Under Torts As stated before, torts include all civil wrongs not based on contracts. As a result, they are a broad residual classification of many private wrongs against another person or organization. Torts occur independently of contractual obligations and may result from: intentional acts or omissions, strict (or absolute) liability imposed by statute law, or negligence. Most torts are based on negligence. Liability consequences of a crime are usually uninsurable. Liability consequences of a civil wrong are usually insurable. Insurance Agents Civil & Criminal Violations Insurance agents can also be found liable for statutory violations, both criminal and civil. For insurance agents whose livelihood is dependent upon their employment, this is an especially serious form of liability since criminal violations can require a conviction and impose fines or imprisonment or both, depending on the severity of the crime. Sometimes the insurance agent is given the option of having a hearing before the state insurance commissioner rather than appearing in court. In other instances, if the agent surrenders their license voluntarily, no further action is taken. Chapter 2, Page 20

24 General Liability Fraud is perhaps the most common crime committed by insurance agents. The following are some examples in the Professional Liability Pitfalls for Financial Planners by Cheryl Toman-Cubbage of real-life cases of crimes committed by insurance agents. In Colorado, a man was involved in a car accident that resulted in almost $7,500 damage to his car and another vehicle. When he contacted his insurance agent, he was assured that the damages would be paid. But, as it turned out, the agent was not licensed to sell insurance in Colorado and had never sent in premium to the insurance company. As a result, the man found out he was uninsured. He had no recourse against the insurance company for the agent s action since, in Colorado; it is unresolved whether an insurance company is responsible for the actions of its salespeople. He sued the agent and was awarded $5,000, but the agent filed bankruptcy, so the plaintiff was unable to collect the judgment. The agent did surrender his license. Another case involved an elderly couple who took the advice of an insurance agent to discard all their old policies and buy the health insurance he sold. They gave the agent a check, but never received a policy. After contacting the company the agent said he worked for, the couple found out he was no longer employed by this company and had no authority to sell its policies. A result of this incident and other circumstances similar to this, the agent s license was revoked and he was convicted of theft and sentenced to five years imprisonment. We have probably all heard of stories of unscrupulous agents taking advantage of their clients. States pass legislation in the hope of reducing fraud, but it is unlikely that laws will ever be entirely successful. What the examples above show is that an agent can receive criminal punishment for acts of fraud they commit. Unfortunately, for many agents who commit fraud, no physical punishment is ever experienced, although they do commonly lose their license to sell insurance. Some agents, however, will simply move to another state and hope that their past does not catch up with them. It has been said that an ethical code of conduct cannot be mandated. An agent is either ethical or not, and laws merely point out those who are not. While this may be true, laws (and resulting punishment) do at least prevent those who lack any ethics from continuing in the profession. Unfortunately, Chapter 2, Page 21

25 General Liability consumers will remember the unethical far longer than the hardworking ethical agent and financial planner. It has been said that an ethical code of conduct cannot be mandated. An agent is either ethical or not, and laws merely point out those who are not. Insurance Agent s Breach of Contract Contracts may involve legal wrongs when implied warranties are violated or contract obligations are breached. An insurance agent would likely not be sued individually for breach of contract. The insurance companies and agencies themselves are more likely to be sued for such a lawsuit since they would be viewed as responsible for denial of a claim or violation of a condition. However unlikely it is that an agent or broker would be sued for breach of contract, it is possible. We can look at the language of the case of Milwaukee Bedding Company v. Graebner: It is a general rule that, where an application for insurance is made to an agent who represents several companies, no contract of insurance is engendered between the insured, and any particular company until such company is designated by the agent. But, where the company is selected by the agent, and in some manner designated as the company in which the insurance is to be written, a binding contract results. In such case the agent becomes the agent of the insured for the purpose of selecting the company. The agent of the above case was found not guilty, but the language describes the traditional relationship between a broker and the insured. It could also be assumed from the opinion that an agent can be liable for a breach of contract to procure insurance. For instance, in the case of Marano v. Sabbio, an insurance broker promised to procure burglary insurance for the client, but failed to do so. Some of the client s property was stolen under covered circumstances. The court held the broker liable for the value of the property stolen under a breach of contract theory. Chapter 2, Page 22

26 General Liability It is also possible for the agent and the insurance company to be sued for failing to act promptly on an application for insurance. This is sometimes presented as a negligent cause of action, but it has also been presented as a breach of an implied agreement to act promptly or as breach of contract. Breach of an Implied Agreement Theory Under the theory of breach of an implied agreement to act promptly, it has been found that the course of conduct of the agent, including solicitation of the application and acceptance of the premium, constitutes an implied agreement that the insurance company will act upon the application without unreasonable delay. Breach of Contract Theory Under the theory of breach of contract it has been found that the application is the offer and silence on the part of the insurance company or silence coupled with retention of the premium forms a contract. This makes the insurance company liable for any unreasonable delays in acting on the application. Legally Binding Insurance Contract It is important to understand exactly when an insurance contract becomes legally binding. As stated before, the application is considered an offer of insurance. The acceptance occurs when either the agent binds coverage or the policy is issued. By law, an insurance contract does not actually have to be in writing. However, it is normally in written form. While there are many reasons for this, one main reason is to determine when the contract was formed so that one may know when a loss is covered. For example, client ABC applies for coverage with XYZ insurance company on his car. By accepting the offer of the client, the agent creates a written contract. If client ABC is involved in a car accident before he receives a written contract, the loss is still covered by XYZ insurance company. Chapter 2, Page 23

27 General Liability By accepting the offer of the client, the agent creates a written contract. If the client is involved in a car accident before he receives a written contract, the loss is still covered by the insurance company where application was made. Relevance The relevance of determining when a contract comes into existence relates to when and if a breach of contract occurs. It is obviously stated that no breach of contract can occur unless a binding contract actually exists. In the past, a life insurance agent could not bind the insurance company. However, in the case of Smith v. Westland Life Insurance Company, the court stated this opinion:... an ordinary person who pays a premium at the time he applies for insurance is justified in assuming that payment will bring immediate protection, regardless of whether or not the insurer ultimately decides to accept the risk. In the case of Young v. Metropolitan Life Insurance Company, the courts stated a similar opinion:... the very acceptance of an advance premium by the carrier tends naturally toward an understanding of immediate coverage though it be temporary and terminable... In short to the ordinary layman, payment of the insurance premium constitutes payment for insurance protection... A Contract of Adhesion In the first case mentioned, payment of the premium had been made. The courts are leaning toward viewing the insurance contract as a contract of adhesion and tend to be harder on the agents and insurance companies in finding a contract early in the negotiations. A contract of adhesion basically means that the insured has no option to change or negotiate policy terms. The policy is presented to the insured on a take it or leave it basis. In viewing courts cases and decisions, it can be understood that any ambiguities in the insurance contract will be construed against the insurance company. Chapter 2, Page 24

28 General Liability For Review: Many financial planners start out as insurance agents or brokers and continue to sell insurance after they move into the financial planning field. For this reason, financial planners will have the same liability problems that they did in the insurance field as well as additional liabilities as financial planners. Even if the financial planner did not start out in the insurance field, they would be involved in providing clients with the risk management advice and even perhaps, would begin selling insurance products. This would thus mean that a financial planner would need to know their liabilities in this field they are expanding to. Financial planners can look to court cases involving insurance agents to gain a better idea of how their field will be likely treated in the courts. Like the insurance agent, the financial planner will be viewed as a fiduciary, holding themselves out to the public as having special skills and/or knowledge. Like the insurance agent, the financial planner can be held liable for negligence, breach of contract and statutory violations. Accountant s Liabilities Looking at how accountants open themselves up to different liabilities will accomplish two things: 1. Help determine the liabilities that need to be covered. 2. If an insurance agent is an accountant also, it will help them determine where they may need to provide adequate coverage for themselves. Chapter 2, Page 25