To be covered or not to be covered
That is a question that too often involves expensive litigation
By Donald S. Malecki, CPCU
Without question, most litigation involving insurance is over whether or not coverage applies. Where litigation over premium disputes ranks is uncertain, there certainly is no shortage of those cases.
On that score, one area where insureds have to be especially careful is with insurance policies that consider all or most of the advanced premium to be fully earned. It usually does not matter whether the subject of insurance has begun or not. Once the period of coverage commences, the policy is considered to have been activated and the premium fully or partially earned, depending on what the policy states.
A case in point is Crestdale Associates, Ltd. v. Everest Indemnity Insurance Company, No. 2:09-cv-02439-LDG-GWF (U.S. Dist. Ct. Dist. NV 2011), which involved commercial general liability insurance of a developer.
The developer (named insured) purchased three separate CGL policies to cover three separate projects. Pursuant to the provisions of the policies, an advanced premium applied to each, based on anticipated receipts from the sales of homes. Each policy also had an endorsement relating to the calculation of the premiums.
This endorsement stated that:
"1. The minimum earned premium shall be fully earned at the inception of the policy and is the greater of: (a.) 25% of the amount entered as the advanced premium, or (b.) the dollar amount shown in the schedule as the minimum premium. There will be no return of the minimum earned premium in the event of cancellation of the policy.
"2. The advanced premium is determined according to the basis of premium, estimated exposure and composite rate shown in the schedule. The final premium will be determined by audit based on the actual exposure. Any audit premiums are due and payable on notice to the first named insured."
The developer purchased these CGL policies during the height of residential construction. While the policies were in effect, however, the residential housing market substantially declined. Ultimately, the developer did not commence construction at one of the locations and, in fact, sold all of the lots to a contracting firm. It also sold 66 remaining lots from another one of its three project locations.
This case involved the dispute where all of the lots were sold to a contracting firm. The minimum and advanced premium of the three-year period applying to the CGL policy that commenced on April 20, 2004, was $277,000. This policy also provided that the advanced premium was fully earned on April 20, 2005. The developer cancelled this policy effective April 2006, subsequent to the date on which the advanced premium became fully earned.
The insurer maintained it was entitled to retain the advanced premium it received. The developer, on the other hand, argued that the policy failed for lack of consideration, contending that: (1) a valid insurance contract requires the insurer to actually undertake the contemplated risk, and (2) because homes were not constructed, the insurer did not confront a risk.
The developer cited several cases for the proposition that insurance policies were not binding until risk attached. The insurer did not dispute that proposition. Instead, it argued that the risk attached under that CGL policy for that location. The court agreed.
One of the cases cited by the developer was Tarleton v. De Veuve, 113 F.2d 290 (9th Cir. 1940). In this case, prior to the payment of the premium, fire destroyed the covered property and the insurer attempted to rely on the nonpayment of premium to escape liability. The court held for the insured, noting that the payment of premium was not required for the policy to be effective.
Both the risk and obligation to pay the premium, it was said, attached to the policy when it was delivered to the broker. Accordingly, this case reflected that the insurance became effective when delivered. Since, in the present case, there was no dispute that the policy was delivered, this Tarleton case actually weakened the developer's argument in the Crestdale Associates case.
Another case cited by the developer that failed to sway the court was Texas Association of School Boards, Inc., 169 S.W.3d 653 (Tex. 2005). The developer raised this case for the proposition that the foundation of insurance was risk distribution, and that premiums are a function of calculated risk.
This case also did not help the developer in the Crestdale case because the consideration to be valued was the undertaking of the risk that insured losses might occur. While the insurer's exposure to the risk of liability was reduced by the developer's failure to build the homes, the court explained, this did not mean that the risk never attached.
To the contrary, the court added, the CGL policy was in effect for two years before the developer sold the property. During that time, the insurer became contractually obligated to anticipate risks resulting from the fact that the developer could have begun construction at any time. The court added that while probability of actual loss was reduced by the developer's actions, the policy was not invalid for want of consideration.
It probably would not have mattered whether a policy was subject to an advanced, earned premium, since the insurer would likely have owed something, if this kind of court decision were to apply. It is just that instead of obtaining some pro rata return, the insurer gets to keep the entire premium.
Workers compensation disputes
Another fertile area involving disputes over premium issues is workers compensation insurance. Some entities simply refuse to recognize that when they do not view the people working for them as employees, they not only will run afoul of their insurance, but also with the IRS.
It is not unusual, for example, where an entity views the people it hires as independent contractors, even though the entity supplies the equipment, work direction and even dictates the hours. When an insurer pulls an audit and finds the risk contrary to what was reported, the entity can expect a very large additional premium.
One such case where a dispute arose was Ed Construction, Inc. v. CNA Insurance Co., No. AC 31476 (Conn. Ct. App. 2011). The contractor met with an insurance agent, completed the ACORD 130 workers compensation application and ACORD 113 application for the assigned risk.
The contractor indicated on the application that it had one employee, and that it provided carpentry services. The estimated premium was determined to be $750 which the contractor paid immediately. After the policy had commenced, the insurer to whom the risk was assigned requested a list of the business operations and certificates of insurance on all of the subcontractors.
Because the insurance certificates failed to indicate the current workers compensation coverage for the subcontractors, and because the contractor submitted "forms for exclusion of coverage by workers compensation law" for individuals who appeared to be employees, the insurer ordered a preliminary audit.
The findings of this audit confirmed the suspicions of the insurer. The audit found that all of the workers the contractor had paid during the policy period had signed a sole proprietor exclusion form and were all carrying only general liability insurance. It was also found that the contractor performed roofing services, rather than carpentry work.
Based on this audit, the contractor's estimated exposure of $1,500, within the carpentry class, was incorrect. The exposure was increased to $114,802 pursuant to the roofing rate class. The insurer also notified that the contractor's payroll was underestimated on its application and that the premium reflected the new annualized payroll. The insurer, therefore, issued a bill to the insurance agency that reflected a premium due of $51,718.
Not surprisingly, the additional premium was not paid and the policy was cancelled. What made matters worse was that two months after cancellation became effective, a worker sustained serious injuries while performing roofing services for the contractor and filed for workers compensation benefits. This caused the contractor to file suit arguing that workers compensation coverage applied.
As it turned out, the contractor lost on its arguments, which were:
(1) The policy was not in force at the time of the injury. The court concluded that the policy permitted cancellation by either party prior to the end of the policy term.
(2) The insurer failed to act on its appeal regarding the increased premium. The court noted that the contractor sent the insurer a letter in response to the premium increase. The court also noted that the insurer explained the procedures that needed to be followed in order to place the audit in dispute.
(3) The contractor claimed that public policy dictated that cancellation of an assigned risk workers compensation policy, during the policy term, defied the humanitarian purposes of the workers compensation act.
The court concluded, nonetheless, that the insurer was entitled to cancel the policy for nonpayment.
The court also noted that the contractor did not cite any authority that supported its claims that the humanitarian purpose of the act prohibited cancellation.
Another case that is worth reading, which involved a premium dispute and a gap in coverage, is Everett Burris v. Propst Lumber & Logging, Inc., et al., No. 4904 (Ct. App. S.C. 2011), which involved another assigned risk matter.
Because the workers compensation policy was cancelled and reinstated, over a premium dispute, a gap was created which, unfortunately, was the time during which an employee was injured.
One of the issues that gave rise to the dispute was whether a premium endorsement was permitted before the final audit at the end of the policy period. Another issue was that the policy's Information Page indicated that the audit premium was annual which, thereby, prohibited the insurer from issuing an interim premium endorsement.
The court ruled on both issues in favor of the insurer.
There is not much producers can do when they are given answers to questions over the nature of an applicant's business.
Declaring that someone's work is carpentry, instead of roofing, for example, is not an isolated circumstance. Contractors have come to learn that roofing is a dangerous business where accidents that happen can be serious and that insurance costs, therefore, can be high.
These situations can be exacerbated when the policy is cancelled for nonpayment and an injury occurs. Unfortunately, too, producers usually get caught up in these problems. While there is little they can do, they may be able to "hint" to prospects what can happen when the information supplied is not as accurate as it could be.
Donald S. Malecki, CPCU, has spent more than 50 years in the insurance and risk management consulting business. During his career he was a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates LLC, an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.