Risk Management
Ousting ambiguities
A look at ISO’s latest revisions to its crime forms
By Donald S. Malecki, CPCU
When it comes to an otherwise covered loss under employee dishonesty insurance, involving a series of thefts over many years, employers often come to the shocking realization that they may be grossly underinsured.
The reason is that there are limitations. The first such limitation is that loss is limited to each occurrence, a subject that was discussed in the April 2008 issue of this column. The second limitation is that the policy limits are not cumulative from year to year. This means that no matter how many years the embezzlements continue, the employer gets only one bite of the apple. In other words, only one limit applies under the applicable discovery or loss sustained form.
A case in point is Landico, Inc. v. American Family Mutual Insurance Company, 559 N.W.2d 438 (Ct. App. MN 1997), where a policy was written for a two-year period subject to a limit of $100,000 per occurrence. During the first policy period, an employee embezzled $47,424, and $102,697 during the second policy period. When the insurer paid the named insured only $100,000, the named insured filed suit seeking the remainder of its unpaid claim.
The court ruled in favor of the insurer, holding that there were no ambiguities with the meaning of “occurrence” and the non-cumulation clause. In fact, the only reasonable interpretation of the non-cumulation clause, according to the court, was that if no claim were to be filed in a given one-year period, the named insured with a limit of $100,000 could not accumulate it and claim $200,000 during the next policy year.
When discussing this subject, it is difficult to make any generalizations because many employee dishonesty coverage forms are not standard. So, instead of utilizing ISO forms, insurers use their own independently filed forms. As a result of some differing policy language, it is difficult to pin down the precise language relied on by courts in cases of dispute.
One thing for sure is that many of the employee dishonesty claims that have gone before the courts have resulted in coverage based on ambiguities. This includes the non-cumulation clause, despite its apparent clarity to contain limits when losses transgress more than one policy period.
In the case of Sherman & Hemstreet, Inc. v. Cincinnati Insurance Co., 594 S.E.2d 648 (Sup. Ct. Ga. 2004), a policy was written for two three-year terms with an occurrence limit of $50,000 and an embezzlement over a period of four years totaling $160,670.
Four years after the original policy took effect, the named insured (employer) discovered that due to an ongoing embezzlement by one employee, it had sustained losses in each of three years of the original policy and during the first year of the three-year renewal policy. The named insured therefore submitted a claim seeking to recover $50,000 for each year of the original three-year policy and $10,670 for the first year of the renewed policy. When the insurer paid the named insured $50,000, explaining that this was the extent of the coverage, the employer filed suit.
The trial court ruled in favor of the named insured. The court of appeals held that under the unambiguous terms of the original (three-year) policy, the named insured’s coverage was limited to $50,000 for the entire three-year period. The problem was with the renewal policy and whether the named insured could recover the $10,670 because the renewed policy set a new limit of $50,000 independent of the original policy.
In this regard, the insurer argued it did not owe the $10,670 loss sustained by the named insured in the fourth year of coverage because of the policy’s non-cumulation clause limited recovery “regardless of the number of years [the] insurance remains in force or the number of premiums paid.”
A crack in the armor was that the court of appeals viewed the non-cumulation clause to be ambiguous because it could be construed to mean either (1) that the insurer’s maximum aggregate liability, regardless of the number of policies it issued, was $50,000, or (2) that the liability limit for the original policy could not be “carried over” to increase the liability limit for the renewed policy, although both policies indemnified the named insured for up to $50,000.
Since ambiguities are construed strongly against the drafter, the court held that the insurer owed the $10,670, because the renewal policy was considered a separate policy that allowed a separate recovery for embezzlement.
One adverse case too many
With adverse decisions mounting against insurers, ISO finally decided to amend the language of its forms in 2006 for a number of reasons, including to strengthen the intent to hold coverage to the limit per occurrence regardless of the number of years the insurance remains in force. One of the cases cited by ISO that helped to determine that some change was necessary with its crime coverage forms is Auto Lenders Acceptance Corporation v. Gentilini Ford, Inc. 816 Atl.2d 1068 (Sup. Ct. N.J. 2003).
This case involved an auto dealership and its sales arrangement with two financial institutions. Customers seeking financing for auto purchases submitted credit applications to the dealership, which were then forwarded to one of the two lending institutions. For each approved application, the dealer would enter into an installment sale contract with the purchaser, taking a cash deposit after accepting the customer’s note. The lending institution would then take an assignment of the dealer’s rights under the customer’s installment contract, including the security interest.
In 1998, one of the lending institutions investigated numerous credit applications that it had accepted through this arrangement. It discovered that an employee of the dealership had engaged in a number of credit application frauds to secure loans for customers who were not otherwise creditworthy. For example, some of the customers were without driver’s licenses, or had fictitious licenses. Others had falsified pay stubs—which were actually the defrauding employee’s own pay stubs.
Following several defaults, the lending institution filed suit against the dealership seeking to have the dealership repurchase all outstanding installment contracts that had not been paid in full. Its demand, in terms of damages, was nearly $832,000. The dealer agreed to pay the lending institution $215,000 in full settlement of the claims.
The auto dealership then sought coverage under a so-called “master pak” endorsement attached to its package policy. This endorsement provided employee dishonesty coverage for no more than $5,000 in any one occurrence. After litigation pursued, the court found that the employee defrauded the lending institution on 27 different occasions. Accordingly, the insurer owed the dealership $135,000.
Focusing on the definition of “occurrence,” the insurer countered with two arguments. First, the plain language of that definition “limits occurrences to one per employee/wrongdoer,” thereby making the maximum payable $5,000. It contended, secondly, that an “occurrence” was not limited to a single event but, instead, to all loss arising from a “series of related acts.”
The court disagreed holding, in part, that the sales did not involve “a single act or a series of related acts,” but were distinct sales to separate purchasers for separate autos. Even though the defrauding employee employed similar techniques for each fraud-induced sale, the court explained, the fact remained that by virtue of the employee’s conduct, the dealership was required to relinquish possession of 27 autos on 27 separate occasions to 27 distinct customers.
The court also stated that the definition of “occurrence” was not clear whether a series of acts could also include acts occurring prior to the inception of the current policy. As a result, the court held that the acts of the defrauding employee at different times were separate occurrences.
Coverage changes
It is not certain whether other insurers will follow suit, but ISO decided in 2006 that the time was ripe to amend its crime forms to eliminate the kind of adverse decisions as in the Auto Lenders Acceptance Corporation and the Sherman & Hemstreet, Inc., cases among many others.
Affected by these changes are the discovery and loss sustained crime forms. Briefly, the discovery form applies to loss discovered during the policy period or within 60 days after the policy period ends. The loss sustained form, on the other hand, applies to loss that occurs during the policy period and is discovered within one year after the policy period ends. This form also provides coverage for loss that would have been covered under a prior policy, except for the expiration of its discovery period.
In the latest revision of the discov-ery form, the definition of “occurrence” is defined as (1) an individual act; (2) the combined total of all separate acts whether or not related; or (3) a series of acts whether or not related; committed by an employee acting alone or in collusion, during the policy period. When discovered, all acts will be considered one occurrence.
The non-cumulation of limit of insurance of this revised form also is deleted. According to ISO, the purpose for deleting this condition is to avoid the inference that limits can be cumulated if a loss extends over more than one period.
The loss sustained form also incorporates the same definition of “occurrence” as in the discovery form; that is, (1) an individual act; (2) the combined total of all separate acts whether or not related; or (3) a series of acts whether or not related; committed by an employee acting alone or in collusion, during the policy period. Since the loss sustained form, however, also includes coverage for loss that would have been covered under a prior policy, except for the expiration of its discovery period, the definition of occurrence also includes this period.
The non-cumulation clause of the loss sustained form likewise has been eliminated. In its place are several lengthy provisions and numerous examples of its application. The first such provision is titled, Loss Sustained Partly During This Insurance And Partly During Prior Insurance. A second provision is Loss Sustained Entirely During the Prior Insurance. Another provision that is new to this form is titled Loss Sustained During Prior Insurance Not Issued By Us Or Any Affiliate.
Conclusion
It will be interesting to see how effective these revisions will be in containing the amount of insurance that has to be paid out when a series of employee thefts take place over more than one policy period. One of the common arguments of insureds seeking insurance recoveries has centered on their payment of premiums; that is, the payment of premium every policy period should count for something when considering a series of losses over more than one policy period.
To avoid such arguments, the non-cumulation clause that was eliminated stated that regardless of the number of years this insurance remains in force, or the number of premiums paid, no limit of insurance cumulates from year to year. With reference to the number of premiums paid no longer applicable, one has to wonder if that might still be a valid argument with the new policy language. Time will tell.
In the meantime, it might behoove policyholders with crime coverages to consider purchasing higher limits, considering that many of the employee embezzle-ments that have taken place generally involve losses over more than one policy period. *