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- For the first time in almost a decade the average Directors & Officers (D&O) Liability insurance policy limit decreased. According to the annual Tillinghast Towers Perrin D&O survey, the average limit dropped from $20.1 million to $18.9 million. High cost was one of the reasons cited for the reduced limit. Premiums were up an average of almost 30% from the prior year. The number and size of most types of claims appears to have stabilized. However, claims involving shareholder actions have increased 143% over the last two years (2000 to 2002).
- A study conducted by the University of Florida in 2002, called the National Retail Security Study, identified an interesting trend. In retail establishments, shoplifting is down, but employee theft is up. The study found that 48% of retail theft was carried out by employees. Shoplifters accounted for 32%. The study credited technology (cameras, surveillance tags on merchandise, etc.) with the drop in shoplifting. Employees, however, appear to have more time and opportunity to find ways to beat the system.
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| Another cell phone danger |
The dangers of using cell phones while driving are well documented. There is another danger caused by the ubiquitous communicators that is lesser known - the ability of cell phones to ignite flammable vapors. Mobile phones give off energy, especially when ringing. Those that light up when switched on or when they ring or vibrate can provide a spark sufficient to ignite flammable vapors.
Some cases are well documented. In one, a phone in a pocket rang while the owner was pumping gas, igniting the vapors and causing burns. Another phone sitting on a trunk lid rang and caused a fire that destroyed the vehicle. A third victim suffered facial burns when answering a call while pumping gas.
Of course, cell phones are not the only potential source of ignition posing a danger to those pumping fuel. As those who live in the mountains or southwest know well, dry air conditions also can cause static electricity. Getting in and out of a vehicle can cause static discharges when one touches a metal part of the auto under such conditions. There are many recorded cases of fueling fires caused only by static electricity.
However, the cell phone does not need dry weather or any condition other than proximity to vapors to trigger a fuel ignition. The best way to handle this potential danger is to turn off your cell phone where the possibility of being exposed to flammable vapors exists. For more information about fueling safety visit the Petroleum Equipment Institute's website at www.pei.org.
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Some insureds may be tempted from time to time to settle claims within their deductibles without reporting the matter to the insurer. This can be risky. Most liability insurance policies have a provision prohibiting voluntary payments by the insured. For example, the clause in the commercial general liability reads as follows:
No insured will, except at that insured's own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without our consent.
As one court has expressed (Roberts Oil Company, Inc. v. Transamerica Insurance Company, 113 NM 745, 833 P2d 222 (1992)), a voluntary payment provision is intended to reduce the possibility of collusion between the insured and the injured third party. Another purpose is to keep the insured from prejudicing the insurer's contractual rights under the policy. However, this court and other courts have placed barriers to an insurer's asserting that it has no obligation just because an insured has made a payment.
One of those barriers is a requirement to show that the payment prejudiced the insurer's ability to defend or control the cost of the claim. Other hurdles for the insurer may arise when the payment is not truly "voluntary" (i.e., the insured had no other choice), or the insurer denies a defense.
Thus, in some cases coverage and defense obligations still exist even when the insured has made a payment directly. But there is still risk in paying voluntarily. Perhaps the most dangerous coverage from the standpoint of the insured is errors and omissions (E&O) liability, including professional liability and directors and officers liability.
E&O policies often go a bit farther than the voluntary payments provision in the CGL cited above. More than just prohibiting payments, E&O policies frequently prohibit any admissions of liability by the insured. Many insureds see these policies as "goodwill" coverage and do not appreciate the legal technicalities of errors or omissions or meeting normal professional standards. An insured can quite easily and unknowingly admit liability where none exists, thereby frustrating the insurer's defense.
It is important to report all claims and incidents that may lead to claims. It is especially crucial under errors and omissions type policies for the insured not to try to settle the claims under the deductible to "keep the claim off the record." There are numerous cases where insureds tried exactly that, and then lost coverage and defense when the claimant came back with a higher demand and the insurer refused to cover the loss based on the voluntary payments provision.
If you anticipate having numerous small claims and would like to handle them yourself, whether within a formal deductible arrangement or not, try to work with your broker to develop a reporting protocol acceptable to your insurer (thus preserving your protection) that will also keep the incidents off your official claims record [see the deductible article in this issue.]
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| Functional replacement cost |
Some older buildings were constructed at a time when labor and certain materials cost far less than today, even in inflation-adjusted dollars. When such structures suffer damage, replacing the damaged components sometimes can be extremely expensive because of the need for labor-intensive processes or custom-made materials. If the owner can accept a substitute for the original and wants to save insurance premiums, a "functional replacement cost" endorsement may be the answer.
Functional replacement cost (ISO form CP 04 38 - functional building valuation) allows for replacement of a functionally equivalent building in the case of a total loss. For partial damage, the form provides for repairs in the same architectural style but of less costly materials if that is possible.
For business personal property such as equipment, machinery, fixtures, etc., the problem may be slightly different. Obsolescence is a major factor. Take computers. A functionally superior replacement probably is available for less than the replacement cost of the original and may be even lower than the original's actual cash value.
On the other hand, the technology may have advanced so rapidly that only a more expensive replacement is available. An example might be a piece of production machinery that can produce five times the output of the old technology but costs twice as much to buy. Clearly, the newer machine is a good economic choice, but a potential insurance problem.
Functional replacement cost for personal property (ISO form CP 04 39 - functional personal property valuation) can handle both situations for functional replacement of personal property. If the new item is less expensive than the original, the insurance limit can be lowered thereby reducing premium. On the other hand if the replacement unit will be more expensive, the endorsement can be used to assure sufficient proceeds to cover the cost of the newer technology.
Use of functional replacement cost endorsements naturally requires a careful analysis of the true cost of replacement. In the case of buildings, standard measures for valuing property may not be appropriate. If your business owns older buildings or uses business personal property subject to rapid technological change, you may wish to consult with your insurance representative about whether functional replacement cost could be of benefit.
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| How to "right-size" a deductible |
There are at least two good reasons for taking the biggest deductible you can afford:
- You should save significantly on premium. If not, don't take the larger deductible.
- Some insurers look hard at claim frequency when considering renewal of an account or when underwriting a new one. Many claims within a deductible are set up as "notice only." The adjuster may file the claim away, but the data never gets into the insured's record.
Determining how much deductible you can afford is a challenge at best. Almost by definition one can never know precisely the right combination of retained risk and transferred (insured) risk. The best one can hope for is to be within an appropriate range. There are a few rules of thumb or common sense approaches. Here are several:
- One rule of thumb says you should be able to cover the cost of a single deductible change with three to five years of premium savings. In other words, a deductible $5,000 higher than your current deductible should save $1,000 to $1,666 in annual premium.
- Consider your cost of money and return on investment and compare to see if you would save by investing the premium savings of a higher deductible or reducing your debt by the same amount.
- Look at your losses for the last five to ten years. You can get a pretty good feel for what your costs within various deductible levels would have been. Of course, the future could be very different. But, some lines of coverage are reasonably consistent.
- Look at all your lines of coverage (property, liability, workers compensation, etc.). The likelihood of simultaneous losses in multiple lines is more remote. Savings in one line can balance losses in another.
- Consider aggregate deductibles (maximum total amount of deductible in a policy year no matter how many losses), if available, to minimize the total risk. For many entities, the issue is one of frequency. They can handle a single deductible loss, but when many occur in the same policy period the total could impact the budget.
- Request quotes at various deductible levels and see if, in light of the above concepts, the savings from moving to a specific higher deductible level justifies the additional risk.
For many publicly traded organizations, and others who report their results, the net after-tax impact on a quarter's earnings per share (EPS) may be the deciding point. What will investors, analysts, or other key interested observers accept? Even after all these considerations, selecting a deductible is still a judgment call. Be sure you are comfortable with and understand the risk. Your insurance representative can be invaluable in helping to make the determination.
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| The National Flood Insurance Program |
Floods cause more devastation than just about any other peril. In 1968 Congress created the National Flood Insurance Program to provide a means to deal with the problem, both financially and through risk management. The Federal Emergency Management Agency (FEMA) manages the program through a department known as the Federal Flood Insurance and Mitigation Administration (FIMA).
In addition to providing a mechanism for writing flood insurance, even in flood-prone areas, FIMA engages in flood plain mapping, flood management, development of ordinances and working with local jurisdictions to implement them. FIMA claims that buildings constructed in compliance with NFIP standards suffer 80% less damage than those not in compliance.
Although funded through insurance premiums, FIMA has authority to borrow from the US Treasury during extremely heavy loss periods. Flood insurance is available through the program in any community that participates. Approximately 20,000 communities are in the program.
Despite the availability of the coverage and the size of the potential losses, many organizations do not purchase flood insurance for various reasons including the belief that "it hasn't happened here so it won't." FEMA points out that 25% of all claims occur in low to moderate risk areas. Considering that in many of these areas property owners forego flood insurance, it is probable that the loss levels in such areas are even higher than the claim statistics would suggest.
The thinking that "it won't happen here" may also reflect a misunderstanding of how floods occur. Floods can be caused by a variety of sources, including heavy rains, melting snow, inadequate drainage, bursting dams, failing levees, storms and hurricanes.
If you are a property owner who has decided to avoid flood insurance because you do not consider flooding a serious risk, perhaps it is time to reconsider. There is a wealth of information about the peril of flood and its prevention and management at www.fema.gov/nfip.
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