February 2009, PIA National - Business Issues Committee. Financial Rating Agencies and U.S. Insurance Markets and PIA Members

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1 February 2009, PIA National - Business Issues Committee Financial Rating Agencies and U.S. Insurance Markets and PIA Members The Current Issues: There are many fallouts resulting from the current financial markets challenges, and others yet to come. One of the many issues to be more thoroughly assess and determine is the central question of: Are changes and improves needed to the current system of financial ratings of corporations, financial instruments and markets? This questions include whether these agencies need a regulatory oversight body, either government or SRO government group, to review and approve their entry into such commerce, as well as authenticate and vet the methods applied; the investigation, assessment, evaluation procedures and processes used; and how does one move the current system and players through such an oversight system? Even the open discussions and questions about the performance of current financial rating agencies such as Moody s, Fitch, S&P and others, encourages these agencies to reconsider/retool their internal operations. These agencies along with A & M Best Company also directly affect and post insurance carrier financial ratings as well. That in turn has impact on PIA members, and ultimately, their customers. Current Actions & Consideration: These questions are engendering various, perhaps premature, attempts by several federal government financial agencies and Congress to press for federal legislative and regulatory restructuring of this financial rating industry. Also, in the fourth quarter of 2008, NAIC announced that they were developing an entity in NAIC that would function as a new financial rating agency. At this writing, it is till very unclear exactly what NAIC meant in December for such a new NAIC entity to address. At the same time, FDIC and TARP each decided that they would financially evaluate and rate insurance entities and instruments. A few life insurers stepped forward and requested TARP participation, while the P&C insurance carrier sector spoke against insurance carrier participation in TARP, as well as FDIC as an evaluator and provided of insurance guaranty funds. And permutations along these lines continue. Any of these actions, individually or in concert, will affect and change current legal understandings of this issue, as well as those that are affected by and surround it. In addition, these changes will establish the future standards of what will constitute prudent, reasonable, customary, and expected care exercised by those having an established

2 fiduciary legal standard of due diligent care to the buyer when placing transactions with and through financial institutions using financial instruments. What This Means to PIA Insurance Agency Owner Members: Lawmakers, policymakers, and interested parties appreciate the need to include financial institutions, equity firms, capital money firms, insurers, and the financial rating agencies in this discussion. Perhaps some might also think to include international megainsurance brokers in the mix as well. Little understood and overlooked in this debate is the Main Street independent agency and independent insurance producer community with their current standing obligations of due diligent care to their insurance customers in matters directly related to these issues. (In this discussion independent insurance producer community does not include independent contracting insurance producers that are contracted and only place with one insurer. The term is meant and includes those independent agents/agencies; brokers/brokerage firms that as a matter of regular insurance business practice place insurance coverages among many different insurers.) This is duty is particularly illustrated by this community s standing obligation to place insurance coverages with financially solvent and authorized insurers and to demonstrations that such obligations were executed for the benefit of the customer. These standards are long-standing, have been fully vetted, and are accepted by the courts. In addition, these standards serve as sound guidance for the day-to-day independent insurance producer practices for the benefit of the insurance customers, and tangible demonstrable action steps and procedures of compliant practice by independent insurance producers before the courts. To both educate and assist public, legal, and marketplace practice policy representatives in understanding what these particular independent insurance producer current due diligence obligations are; what standards of practice apply; the variation expected per nature of coverage placed; and the vetted legal demonstration accepted by the courts to show the insurance producer properly exercised these obligations, PIA National provides this summary of current standing law, expectation and practice applied to independent insurance producers in all 55 U.S. insurance jurisdictions. In doing so, PIA National underscores the importance and urgency with which we enter these discussions for due consideration and inclusion of our member interests (Main Street, Retail, Independent Insurance Agencies selling all forms of personal and commercial insurance in property-and-casualty, as well as life-and-health insurance). Our goal is to as best possible maintain a clear, stable and legally reliable due diligence process. Doing so, first and foremost, benefits the insurance buying public by providing

3 clear guidance and practices upon which a consumer may rely, and brings reasonable legal clarity and certainty to PIA members as they conduct their insurance producer operations. February 2009 Article - PIA Main Independent Insurance Agencies Placements of Coverage Carrier Stability The insolvency of an insurer presents a potential challenge to any insurance producer that has placed policies with that insurer. There is a fundamental insurance law principal stating that: Insurance producers shall place insurance coverage with an insurer that at the time of the placement is deemed to be solvent and authorized by the appropriate state department of insurance. This insurance law expectation is uniform across all 55 U.S. insurance jurisdictions and weighs most heavily (if not exclusively) on insurance producers that have multi-insuring markets/carriers with which to place insurance coverages, i.e. independent insurance agencies and insurance brokerage firms. Therefore, the relevant question that may arise if the insurer (with which this insurance producer has placed insurance coverages) later become insolvent is: Did the insurance producer take care to know the financial condition of the insurer when they placed the business? Generally, an insurance producer is not responsible for any lose an insured might incur due to an insurer s insolvency and/or the limitations of the state guaranty funds, if applicable. However, that is predicated on the insurance producer executing certain duties. An insurance producer s error or omission in failing to discharge and/or inability to demonstrate execution of these expected actions may create liability. The due diligent standard for and demonstration that an insurance producer acted with reasonable, prudent, customary and professional care regarding the solvency and authority standing of the carrier at the time of placement is generally well established in insurance common law between and among all 55 U.S. jurisdictions. In conjunction, the courts recognize that the scope of duty will be scaled upwards each step an insurance placement moves away from standard insurance placements with an insurer that is fully admitted and regulated in the state. In other words, the more exceptional/specialized the insurance coverage, placement and/or insuring entity is, the more expert and knowledgeable the courts will hold the insurance producer s due diligent efforts to be.

4 This is based in the fundamental principal that in court there are no sophisticated insurance buyer as compared to the insurance producer upon whom they relied to make the insurance placement. Since the courts view that the insurance customer is ill equipped to determine the solvency of an insurance provider on their own (with sound reason), the law places a burden upon the independent insurance producer to ensure that at least a minimum level of care (scaled) is undertaken to protect the consumer. And the courts will increase their level of expected responsibility on the part of the insurance producer as the specificity and uniqueness of the coverage and placement process increases. What lengths are required of an independent insurance producer to fulfill this requirement? In general, the accepted legal demonstration of reasonable care by an insurance producer is established in light of a few relevant considerations, such as; 1. Be sure to appreciate that the term and/or action of placement can and may mean as affecting each new policy of insurance, renewal policies of insurance, endorsements adding additional items of value to be insured and/or coverages for them, and in some circumstances may apply to continuing policies of insurance. 2. Per the relevant state, and for standard insurance placements, the insurance producer shall verify that the insurance carrier is licensed, solvent, and authorized to conduct the nature of insurance per the placement(s) in question. The easiest method to determine the carrier s status for all three areas is to contact the applicable state s insurance commission or bureau. This step is the minimum level of care and diligence expected by any insurance producer (including captive/exclusive/controlled insurance producers). An insurance producer will most likely be held liable (as well as noncompliant from an insurance administrative law standpoint) for any losses incurred as a result of placement with an unlicensed and/or unauthorized carrier that was insolvent at the time of the placement, and in many cases, bear some liability if insurance is placed with an unlicensed, unauthorized insurer that subsequently becomes insolvent. 3. Insurance coverage may (and at times must) be placed with insurers that are not licensed-admitted in the applicable state. The basic threshold changes in these cases. Insurance producer shall take care to assure that the insurer is authorized (or at least not prohibited) to conduct the nature of non-admitted insurance being placed, as well as being solvent at the time of the placement and including the additional following measures. 4. Under non-admitted circumstances, specialty insuring entities, and in some states more broadly applied (to include all insurers), the insurance producer is expected to take additional steps. This is especially true for producers with regular

5 access and practice to multi-insurance markets. These insurance producers should know the carrier s current financial standing published by one or more of the recognized (court accepted) insurance rating services, i.e., A.M. Best Company, Standard & Poor s Corporation, Duff & Phelps, Fitch and Moody s. (Per E&O prevention, PIA suggests members use two rating services, with Best being one, since the courts still clearly recognize and accept the insurance rating expertise of Best.) Insurance agents and brokers have been found liable for a customer s loses due to carrier insolvency, where they placed insurance coverage with a particular insurer assigned a very unfavorable evaluation and serious rating downgrade. Conversely, courts have found that insurance producers satisfy this duty by executing a pattern of practice that includes the actions that comply with points #1, 2, and 3 of this section before placing coverage. 5. It should be noted that insurance producers are not required to place coverage with the best carrier. The courts do not recognize and have rejected attempts to establish a best standard. Courts expect at minimum only that the carrier is solvent, authorized and has received a sound and reputable financial rating from a worthy rating bureau. Courts generally recognize a standard of reasonable, prudent, customary and professional due diligent (barring exceptional considerations and circumstances in a particular case, but as applied to that peculiar set of facts and circumstances). 6. Further, when it comes to non-admitted insurers and/or unique insuring entities such as captive, reciprocal, exchanges and the like, the insurance producer shall add an additional step in taking care to only place business with an entity that also meets the previous requirements and has not fallen below the minimum risk-based capital/stock/surplus measures set by state for the nature of insuring entity and risk coverage being placed. 7. When seeking reference for placements in Step #6, it may be advisable for an insurance producer to also add additional methods and/or sources of information that may be useful in determining a carrier s solvency to further protect their insurance customers and shield them from possible liability. 8. However, it is crucial for insurance producers in performing Step #7 (and as a general guideline for all reference materials and sources relied upon by insurance producers in executing these duties) to only use methods and/or sources of information that are credible, have a reasonable level of insurance professional vetting, are suggested by insurance experts in this field, are accepted/used (or at least not rejected) by state departments of insurance in their internal assessments of insurers, and have an acceptance by the courts. Further Last Practice Notes:

6 1) On a regular basis know the financial standing (per review of financial rating bureaus) admitted, and authorized status of any insurer with which you regularly conduct your insurance placements, as well as with any insurer with which you place insurance business. 2) Be aware and follow up on any published information from reliable sources that may suggest significant financial strains on a carrier with which you do business. 3) The same goes for any information about any state insurance department s action against a carrier potentially affecting their authorized status and/or in their financial area, i.e. request for more reserves and the like, and/or the authorization/approval area. 4) Know the fundamental insolvency laws, their benefits and limitations and how they would execute response in your state as to nature of policies covered or not covered, limits of coverage provided, when coverage is terminated after a carrier is under an order of insolvency, and the like. 5) State s applicable state guaranty fund laws for P&C PL vs. CL, as well as Life insurance are materially different. These funds have different levels of MAX limits of coverage available; certain lines/classes of business that are excepted from coverage, different deductibles, as well as claims processing, and these differ from state-to-state. 6) Today most states provide 30-days of policy effected coverage from the date of ordered insolvency after which all coverage automatically terminates. 7) However, know that the insolvency law and timings of the insurer s state of domicile will control which may not be your state of resident or the state in which your affected customer s insurance coverage. 8) Confirm whether your E&O liability policy provides coverage for insolvency claims, and, if so, what modifying and/or limiting conditions does your E&O policy impose? 9) In today s marketplace, many E&O carriers have entirely stopped providing coverage for losses due to insolvency or bankruptcy of an insurer. However, for those that still provide this coverage, the policy s coverage may be limited. For example, an E&O policy may provide coverage only for carriers that have a certain rating, and/or may limit coverage to insolvencies declared after a certain period of time form the inception of the policy. We welcome, value and rely upon your comments, suggestions and/or questions, and please direct them to patbo@pianet.org.