There is more than one way to skin a cat! When this old saying is used in conjunction with insurance matters, it is another way of saying that there is more than one alternative or way to look at a given situation regarding the prospects of coverage.
Take, for example, the frequency of white-collar crimes by company employees and independent contractors. Both loss exposures can be handled by fidelity insurance. However, the fidelity coverage procured sometimes is insufficient to handle a given loss. For example, it takes an endorsement to a crime insurance policy to add coverage against loss by independent contractors. Underwriters sometimes are reluctant to add such independent contractor endorsements without first conducting some very careful research, because these exposures sometimes are more difficult to control than those involving employees.
In an actual case some years ago, guests' valuables contained in room vaults of a hotel were disappearing. An investigation revealed that the only known culprits had to be employees. Unfortunately, the hotel did not maintain high enough limits under its innkeepers liability and hotel safe deposit liability policies and began to look for other coverages for the large loss with which it was confronted.
A review of the hotel's insurance portfolio revealed a commercial general liability policy with limits far in excess of the total loss. The task was to convince the insurer that the CGL policy covered theft of property as property damage. Some people may think that it is impossible for a liability policy to cover theft losses for which an employer is responsible. However, that idea was put to rest with this columnist's article in the December 1991 issue of Rough Notes, titled "Property Does Not Have To Be Damaged For PD To Apply Under CGL."
Briefly, the article mentioned that personal property lost or stolen is considered to be loss of use of tangible property not physically injured. There are cases supporting that opinion. The article went on to explain the obstacles sometimes raised by insurers, and how they could be overcome--given the proper fact pattern.
For example, a common reason for denying coverage of the employer's liability for theft of another's property is the Exclusion j., dealing with property in the insured's care, custody, or control. What is overlooked here is the concept of severability of interests. If the stolen property was in the custody of the thief, how can it be said to have been in the custody of the employer? While the CGL insurer does not have to protect the alleged thief, coverage for the liability imputed to the employer should be covered.
To combat these kinds of arguments, some insurers have added property theft exclusions to their independently filed commercial general liability forms. A criminal act exclusion applying to any insured also may serve the same purpose.
Another recent coverage inquiry involved theft by an independent contractor (bookkeeper) of tax money owed to the IRS by a business. The fact that the bookkeeper was caught and sentenced for her crime did not absolve the employer of its debt. The problem confronting the producer in this case was that the fidelity coverage provision was limited to loss caused solely by employees of the named insured.
There is no reason why the employer in this case could not also look to its commercial general liability policy for the payment of those amounts owed to the state government seeking them.
Another alternative
Another alternative for coverage recently sought by an employer was under its employee benefits liability (EPL) coverage. This coverage was first introduced in the early 1960s, largely as a result of the landmark case of Gediman v. Anheuser Busch. Although commonly added by endorsement to CGL policies, this coverage also is written in conjunction with fiduciary liability policies to encompass liability under the Employee Retirement Income Security Act (ERISA) of 1974.
The intent of this coverage is to protect entities, their partners, officers, directors, stockholders, and certain employees who are authorized to act in the administration of any benefits plan in the event of claims made against them by prospective, present, or future employees, their beneficiaries, and legal representatives. The damages payable stem from negligent acts, errors, or omissions in the administration of various plans.
The case in question is Benilde-St. Margaret's High School v. St. Paul Mercury Insurance Company, 575 N.W.2d 127 (Minn.App.1998). Briefly, the facts are as follows: A parochial high school brought an action against its insurer, under employee benefits liability coverage for loss of employees' contributions to Social Security benefits which the school paid to its payroll vendor. That vendor not only misappropriated the funds but also went bankrupt.
The school had hired this independent vendor to cut costs. The procedure of this vendor was to make electronic transfers from the school's accounts to pay employees and to collect payroll deductions. The vendor was supposed to forward the deductions--such as withheld taxes and Social Security taxes--to the Internal Revenue Service (IRS) and other appropriate agencies. The amount misappropriated was approximately $184,000.
Because the school was held to be responsible for the loss by the IRS, the school entered into a repayment agreement with the IRS to pay $4,000 per month until the debt was paid in full. In the meantime, the school sought coverage under its EPL coverage. The reasons for the insurer's denial, and the court's disagreement with the insurer and its rationale are as follows:
(1) The insurer argued that the amount owed to the IRS was required by federal law and, therefore, would not stem from the administration of an employee benefits program. The court stated that, while it is true that the moneys were required by federal law, it does not hold true that they do not also arise from the administration of employee benefits. In fact, if the administration of benefits had been executed properly, said the court, to meet the requirements of federal law, there would be no loss.
(2) The insurer next argued that the claim was not covered because the policy states that it covers amounts the named insured is required "to pay to compensate others." The insurer maintained that the IRS was not seeking compensation, but instead was merely collecting revenue. The court, on the other hand, stated that the moneys misappropriated were no longer the school's, but belonged to the IRS. Therefore, it was the IRS that suffered a loss by absence of its Social Security moneys, for which it sought compensation.
(3) The insurer then argued that the school's liability did not result from an error, omission, or negligent act, as required by the policy. The court countered this argument by stating that it was a negligent act of the school to have failed to properly investigate the vendor before engaging it for payroll services.
(4) The insurer also maintained that the school did not directly administer employee benefits and therefore was not subject to coverage. This argument, the court stated, introduced specifications not present in the policy. In a case involving the same type of coverage, this court stated that because the insurer failed to define "administration," the court had no other alternative but to use the plain meaning of the term, which it said includes "the direction or oversight of any office, service, or employment."
(5) Another argument of this insurer was that the district court erred by determining that the vendor's actions constituted a wrongful act because intentional misconduct cannot be included in coverage limited to errors, omissions, or negligent acts. The court stated that this argument was misplaced among reasons being (a) the vendor was neither an employee nor an insured under the policy and its conduct, therefore, was not subject to coverage; and (b) the insured act was the school's failure to investigate the vendor's financial security.
(6) The insurer asserted that the loss for which the school was seeking coverage is a first-party loss, as the IRS has not suffered a loss. Since the policy offers solely third-party coverage, that loss is not covered by the policy. The court agreed that the policy applies to third-party liability but rejected the insurer's argument that the IRS has suffered no loss. Simply because the IRS has extraordinary powers of collection of moneys it is owed, and simply because the IRS transferred that loss to the school, did not make the school's claim a first-party claim, the court said.
(7) The insurer also maintained that the school would require a fidelity bond to cover its loss. The court disagreed, stating that a fidelity bond protects an organization from a loss due to the dishonest or fraudulent acts of its employees. The court added that the vendor was not an employee, but rather an independent contractor, and that no school employee committed a dishonest or fraudulent act connected with this claim.
(8) The insurer also relied on its policy's exclusion titled, "Fines, taxes or penalties." It reads: "We won't cover fines, taxes or penalties imposed by law or other matters which may be uninsurable under law." The court stated that this argument is dependent on the classification of the Social Security moneys as taxes. According to the court, however, this tax exclusion did not apply, because the policy itself listed "Social Security system benefit" under its list of definitions of employee benefits.
While there was dissenting opinion by one justice, the insurer was required to provide coverage for the loss sustained by the school by reason of its error, mistake, or negligent act in the administration of the employee Social Security benefits program.
Conclusion
As was mentioned earlier, there is more than one way to "skin a cat." However, one cannot assume categorically that another form of insurance will always apply when a coverage form falls short of the mark. Much will depend on the facts and the policy provisions in question.
However, it certainly is worth the effort for one to explore other possible ways to obtain protection when clients are in dire need. The fact that the court in the above case mentioned that fidelity coverage, for example, is limited to loss by employees is not totally accurate, since it is possible to add coverage for loss caused by independent contractors (or agents). On that score, it may be a good idea for producers to cultivate these other coverage avenues so that if one alternative does not apply, another may be readily available--without there having to be a desperatehunt. *
The author
Donald S. Malecki, CPCU, is chairman of Donald S. Malecki & Associates, Inc. During his 37-year career in insurance and risk management, he has worked as a broker, a consultant, an underwriter, and an editor. He is the author of nine books, including Commercial General Liability: Occurrence and Claims-Made Forms, The Additional Insured Book, and three textbooks used with the CPCU curriculum. He is chairman of the Senior Resource Section of the CPCU Society, serves on the Examination Committee of the American Institute for CPCU, and is an active member of the Society of Risk Management Consultants.
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