Complications With Compliance
Wage-and-hour lawsuits are the bane of employers, and few industry sectors are as challenged by the Fair Labor Standards Act as retailers, with their multitude of part-time, minimum-wage workers and the potential for misclassifying employees who might be due overtime pay.
The difficulties will only increase as demands for a higher minimum wage grow at the federal level and in various states and cities throughout the country.
But retail risk managers have more on their plates than complying with the FLSA — or struggling to model how potential wage hikes will impact the organization. An even more cumbersome and complicated entree is new Affordable Care Act reporting rules, which are kicking in this year.
These two items are not only adding to retailer regulatory risks, but they also have the potential to increase costs for workers’ compensation and general liability policies. Not to mention the possible multimillion-dollar wage-and-hour lawsuit settlements, which are not uncommon for large employers.
New Reporting Regulations
“The [ACA] reporting is a challenge, partially because it’s new but also because of the timing in the way it was rolled out — the expectations and overall complexity of what employers have to do,” said Jay M. Kirschbaum, practice leader, national legal and research group, Willis Human Capital Practice.
“We might call it the spiked tail on the beast they have been grappling with for a number of years,” said Edward Fensholt, senior vice president, director of compliance services, Lockton.
According to a 2015 PricewaterhouseCoopers survey, only 10 percent of employers have an ACA reporting solution in place, and 16 percent have not even considered a solution yet.
Nearly two-thirds (65 percent) said the quality of the data they will use to determine health care eligibility is a concern.
Beginning in January 2016, employers subject to the ACA reporting requirement must file with the IRS a Form 1094-C and, for at least each full-time employee, a Form 1095-C detailing data on employees and, in some cases, their dependents related to health care eligibility and affordability in 2015 under the ACA’s employer mandate. Employees also must be notified.
“We might call [ACA reporting rules] the spiked tail on the beast they have been grappling with for a number of years.” — Edward Fensholt, senior vice president, director of compliance services, Lockton
Employers face a $250 fine for each form that is not filed, up to a $3 million maximum, said Fensholt, although he noted the IRS has indicated a willingness to allow slight filing extensions and to excuse some errors or failures if the employer made a good faith effort to comply.
For retailers, the issue is made more problematic by high turnover in the industry; the preponderance of hourly employees, many of whom may fluctuate between full-time and part-time employment; multiple locations; new coding requirements; monthly reporting rules; and for large employers, mandatory electronic filing.
“They are all scrambling to figure out what they are going to do,” Kirschbaum said. “The payroll industry has not covered itself in glory in getting packages together, but in their defense, I don’t think they had much advance warning.”
And for those employers that did not proactively begin planning and lining up key partners — and many employers postponed action until after the Supreme Court ruled on the constitutionality of health care subsidies in June — some are now finding themselves left to their own devices.
“The demand for that service is so high,” Fensholt said, “that many of these payroll and other vendors said this summer that they are not taking any new customers. They are at maximum capacity.”
In addition, because many employees in the retail industry have variable hours or are part-timers, some companies may be challenged to respond to notices from health care exchanges about subsidized insurance. When employees apply for subsidies, employers must validate or challenge the subsidy. Failure to respond on a timely basis could trigger penalties, according to PwC.
“Particularly for multi-state employers with many worksites, responding to the exchange notices on a timely basis could be very challenging since state exchanges may vary in their notices and response procedures,” according to PwC.
With ACA compliance added atop the possible flux in the minimum wage, it’s clear why regulatory concerns are considered a top risk for retailers, according to the 2015 “BDO Retail RiskFactor Report.”
“Federal, state and/or local regulations” tied as the No. 1 risk with “general economic conditions” and “competition and consolidation” in BDO’s most recent report. It was No. 2 in both 2014 and 2013, and No. 4 in 2012.
Many of the employee recordkeeping challenges retailers face in complying with ACA regulations are also challenges for wage and hour issues, but the growing demand for a $15 an hour minimum wage (already adopted in Seattle, San Francisco and Los Angeles and for fast-food workers in New York), plus a proposed minimum wage hike at the federal level — from $7.25 an hour to $10.10 an hour — add more complexity.
When Walmart recently hiked its minimum wage for new workers to $9 an hour — to increase employee engagement and customer service — grumbles arose among longer-term employees who received no raise and felt their experience and commitment were being undervalued.
Part of the modeling some companies are doing looks at not only the increase to minimum wage but also increases in wages for others in the organization, said Brandi Boles, vice president, Lockton.
“It’s a true domino effect,” she said.
In addition, the U.S. Department of Labor has proposed raising the salary threshold used to determine whether employees are eligible for overtime pay from $455 per week to $970 per week.
That may require employers to reclassify part-time managers or administrative employees who are on a salary basis, as hourly, nonexempt employees.
“That could create some challenges for companies,” said Adeola Adele, executive vice president and EPL product leader, Willis FINEX practice. “It’s not just about adjusting the salary, it’s about the actual responsibilities the employee has.
“Ultimately, the challenge is one of classification [of workers as exempt or nonexempt],” she said. “Retailers have to stay even more vigilant in the way in which they attempt to comply.”
A final rule is expected to take effect in 2016. If so, it “would impact 5-10 million workers, many of whom are concentrated in the retail and hospitality industries,” according to Alex Passantino, leader of the wage and hour litigation practice group at Seyfarth Shaw. “Some other estimates believe the number of impacted employees is more likely to be in the range of 15 million.”
The National Retail Federation puts the number of affected retail and restaurant workers at 2.2 million, and estimated it would cost $745 million to comply with new federal regulations.
The cost of federal wage-and-hour lawsuits is already astronomical. The number of FLSA lawsuits filed against employers has increased by more than 300 percent since 2000, from 1,854 claims in 2000 to 8,126 cases in 2014, according to Seyfarth Shaw, which tracks such litigation.
The proposed FLSA rules are “definitely going to create challenges,” Boles said. “It’s already creating challenges.
“There’s a lot of time and effort running a lot of modeling, looking at different angles. What has to happen, what needs to happen if these changes were to occur,” she said.
If labor costs increase due to a wage hike, retailers, already battling thin margins, may be forced to increase product prices. And that could impact insurance premiums.
Because workers’ compensation insurance is based on employer payroll, companies would undoubtedly see carriers asking for increased premium costs should the minimum wage be hiked, according to Lockton.
“I am looking at ways to be able to offset and/or credit policy audits as a result of the pure minimum wage impact,” Boles said. “We are working with individual carriers to create strategies to acknowledge the fact that individual company exposure has not changed, and it’s just due to a minimum wage increase.”
Thus far, carriers have been receptive, she said.
But because retailers may opt to increase product prices to offset the potential labor costs, they also would likely see their general liability policy premiums increase, since they are based on revenue.
“I am looking at ways to be able to offset and/or credit [workers’ comp] policy audits as a result of the pure minimum wage impact.” — Brandi Boles, vice president, Lockton
Wage-and-hour lawsuits generally fall within the scope of employment practices liability insurance, but most policies exclude coverage for violations of the FLSA or similar state or local laws, according to attorneys at Dickstein Shapiro.
The attorneys noted, however, that even if indemnity coverage is ultimately excluded, the carrier may have a duty to defend the employer if the complaint includes the possibility that one of the claims is potentially covered by the policy.
Adele noted that the Bermuda market within the last two years has developed a stand-alone wage-and-hour insurance policy to respond to such allegations, covering defense and indemnity costs.
Contrary to some brokers’ expectations, though, the coverage has not seen significant take-up, she said, partly because the premium is still relatively high and the minimum retention is $1 million.
“Not every company is willing to take that kind of retention,” Adele said. “I think over time, as more competition is introduced, there will be more interest in wage-and-hour insurance and the policies will probably become broader to address some of the emerging wage-and-hour risks.”
However, she said, with the current volatility, “I think insurance carriers are treading very carefully to make sure they are insuring a loss that would still be profitable for them.”
Profitability, of course, will also continue to be the major factor underlying the struggle of retailers as they attempt to meet these complex regulatory demands.
Insurer To Pay “Extra” Expenses
On May 22, 2011, a tornado struck Joplin, Mo., substantially damaging the Midwest Regional Allergy, Asthma, Arthritis & Osteoporosis Center and its contents.
While at the temporary location, Midwest Regional did not accept new patients, operated at a reduced schedule and did not install various pieces of specialty equipment — such as an MRI machine, X-ray machine and bone density machine — because of space restrictions and other reasons.
The new location finally opened on May 1, 2012, and Dr. Joseph requested additional reimbursement from Cincinnati Insurance Co. under the “extra expense” provision of his business owner’s policy for the cost to repair and relocate the MRI machine and other specialty equipment.
Cincinnati Insurance had already paid Midwest Regional the policy limits of $2.4 million for building loss, $388,000 for business personal property loss and $828,100 for business income interruption and extra expenses.
It denied the physician’s request for the additional payment, contending that the specialty equipment expenses had already been covered under the building and personal business property provisions.
After Midwest Regional filed suit in the U.S. District Court for the Western District of Missouri-Joplin, the federal court ruled the expenses were recoverable under the extra expense provision. It noted that the policy was ambiguous and therefore should be read as providing coverage.
Although the insurer and physician subsequently settled, the insurer appealed the court decision to the U.S. 8th Circuit Court of Appeals.
Cincinnati Insurance argued the expenses were not recoverable because they were connected to the policy’s business income provision. It also argued the request was the insured’s attempt to circumvent the policy limits of the building and business personal property provisions.
The court ruled on July 31 that “an ordinary person of average understanding” would interpret the policy’s definitions of extra expenses as “distinct and separate” from the business income provision, and that the policy “specifically states that ‘Extra Expense’ coverage is not subject to the policy limits.”
Scorecard: Although the insurance company had already agreed to a settlement, the ruling underscored that reimbursement was covered under the policy.
Takeaway: Because the policy did not clearly prohibit reimbursement of the extra expense coverage, “an ordinary person” would expect the insurer to pay the disputed amount.
Court Rejects Claim
On April 7, 2011, a custom-built bookmobile for the City of Beverly, Mass., was destroyed after fire spread from a nearby vehicle at Moroney’s Body Works Inc.
The city refused to accept delivery of the damaged bookmobile, and Moroney submitted a claim to Pilgrim Insurance Co., which had issued a garage insurance policy, and to Central Insurance Cos., which had issued a commercial property insurance policy.
Pilgrim paid $12,450 to Moroney, based on an appraiser’s estimate of repair costs. Central denied coverage, asserting that its policy was not triggered until Pilgrim’s coverage was exhausted.
Moroney sued both insurers in Massachusetts Superior Court, after which Pilgrim settled the case, with a total payment of $30,668. The judge found in favor of Moroney, and ordered Central to pay $126,232 – which was the difference between the original contract price for the bookmobile ($156,900) and the amount received from Pilgrim.
Central appealed. On Aug. 6, 2015, the state’s Supreme Judicial Court reversed the decision.
It ruled the “other insurance” provision in Central’s policy meant that it did not come into play until Pilgrim’s limits were exhausted. It also agreed with Central’s other argument that if it did have liability, its coverage was limited to the cost to repair the bookmobile.
“Because both policies insure the same insured’s interest (Moroney’s ownership) in the same property (bookmobile) against the same risk (fire), Central’s ‘other insurance’ provision applies,” the court ruled. “Accordingly, Central’s liability does not begin until Pilgrim’s policy limit is exhausted.”
The three-panel judicial panel also ruled that Moroney was not entitled to receive anything more than repair costs.
Scorecard: The insurance company did not have to pay $126,232 for the claim.
Takeaway: Claims involving “other insurance” clauses often default to allocation of liability between carriers, whether it is excess, such as in this case, pro-rata shared liability, or escape clauses, which result in no payment.
Paralyzed Man Can’t Collect From Insurers
In September 2009, Scot Vandenberg fell from the upper deck of a 75-foot chartered yacht during a five-hour cruise. The bench he was sitting on tipped over when turned around to speak to someone. It left him paralyzed from the chest down.
Rose Paving was insured by Westfield Insurance Co. for commercial general liability and an umbrella policy.
Vandenberg settled liability claims against the owners and operators of the yacht for $25 million on Oct. 10, 2012. In addition, RQM’s insurer paid $2 million; Rose Paving, Michael Rose and Alan Rose agreed to pay $300,000. The $25 million was to be satisfied through an assignment of rights of recovery under their insurance policies.
Earlier, in January 2012, Westfield had sought a court determination that it owed no duty to defend or indemnify Rose Paving. It noted that Rose Paving represented that it did not use watercraft on its insurance application and that the CGL policy had a “watercraft exclusion.”
A federal district court in Illinois agreed.
On appeal to the U.S. 7th Circuit Court of Appeals, Vandenberg argued the policy did not expressly exclude accidents on the yacht. He also argued that even if Rose Paving was designated a construction business, the policy should extend to all of that corporation’s businesses, including yacht charters.
The federal appeals court rejected the arguments, noting the insurance policy only covered premises and operations “in connection with construction, reconstruction, repair or erection of buildings.”
“A policy does not need to exclude from coverage liability that was not contemplated by the parties and not intended to be covered under the agreement,” according to the ruling.
“Such a speculative exercise in hypotheticals [such as requiring Rose Paving to explicitly exclude all possible risks] would be nonsensical,” the court ruled.
Scorecard: Westfield Insurance Company did not have to pay $25 million to settle the liability claim.
Takeaway: For Vandenberg to succeed, he would have had to prove his injuries were wholly independent of any negligent operation of the watercraft.
Surplus Lines See Pressure on Rates
Excess capacity, an abundance of capital and few CAT losses are driving pressure on rates in many lines of business, yet premiums are rising as well. That’s the situation for surplus lines, said Brady Kelley, executive director of the National Association of Professional Surplus Lines Offices.
The annual NAPSLO conference earlier this month in San Diego drew about 4,200 brokers, carriers and other insurance professionals – a new record attendance, Kelley said.
The slowly recovering economy is increasing the need for surplus lines coverage, he said, noting a 6.7 percent growth in surplus lines direct premium written (DPW) in 2014 over the prior year, reaching $40.2 billion – the highest in history, according to A.M. Best.
While surplus lines carriers continue to “feel pressure on rate,” he noted that “there is a lot of optimism. The market is growing and that’s a good thing.”
As always, cutting-edge carriers are tackling the latest risks associated with drone technology, driverless cars and the sharing economy, such as Uber, as well as an ongoing demand for cyber protection, he said.
Some of the legislative items NAPSLO is paying attention to are adoption of a flood modernization bill that would continue to allow surplus lines carriers to provide coverage; formation of the National Association of Registered Agents & Brokers (NARAB II) board that would streamline nationwide registration of brokers; and exemption from the “burdensome” Foreign Account Tax Compliance Act (FATCA) regulations that require brokers to collect premiums from clients on behalf of foreign carriers
No End in Sight for M&As
Mergers and acquisitions in the insurance industry will continue due to excess capacity, a need for expertise and talent, and the benefits of scalability, said Alan Jay Kaufman, chairman, president and CEO of Burns & Wilcox.
The impact for risk managers will be fewer choices, he said.
“They will have more limited opportunities,” Kaufman said. “Risk managers will have to be better. They will have to have more expertise to deal with expertise. Experts want to deal with experts.”
Among the major M&A’s impacting both insurers and brokers, are Ace/Chubb, XL Catlin, AmWINS Group/Colemont Insurance Brokers, Tokio Marine/HCC Insurance Holdings, Global Indemnity/American Reliable and Fosun Group/Meadowbrook Insurance.
“These are very large acquisitions of consequence, and what is that going to do for our world?” — Alan Jay Kaufman, chairman, president and CEO, Burns & Wilcox
“There seems to be a heightened interest in who’s next,” he said. “These are very large acquisitions of consequence, and what is that going to do for our world?”
He envisions more limited distribution by insurers “in order to get more market share.”
“The relationship of being a broker or MGA is going to become more valuable in the future,” he said.
The lack of talent and the need for expertise is a key reason for the M&As, he said
“The insurance industry overall doesn’t have enough new talent coming in,” he said. “That’s why people are taking from each other.”
But, he noted, companies don’t have to be big to have expertise. “There will always be a place for expertise in boutique companies.”
Need for Technology
Commercial lines insurers are, generally speaking, behind the technology curve, at least as it comes to providing user-friendly web platforms for clients or the brokers that serve them.
“Where I believe insurers have made significant progress over the last decade or so, it’s been notably in the personal lines arena, such as travel, life, health or auto insurance,” said Michael Sillat, president and CEO of WKFC Underwriting Managers, a subsidiary of Ryan Specialty Group.
He noted, however, that there are a growing number of standard commercial business policies that can be procured on the web these days as well.
“Carriers that offer, or are developing products that a web platform can help distribute, quote, bind and issue, have been, and will continue to become more and more prevalent in future,” he said.
“For now, I think all insurance companies are at least looking at it.
“No doubt, some probably wonder how on earth they can do it, but in my opinion, they have to, whether they develop the technology in house or outsource to an entity with such capabilities.”
“Carriers that offer, or are developing products that a web platform can help distribute, quote, bind and issue, have been, and will continue to become more and more prevalent in future.” — Michael Sillat, president and CEO, WKFC Underwriting Managers
A big part of the process requires developing sufficient intelligence, driven by data analytics and predictive modeling, to create and implement pricing algorithms, so that insurers can integrate risk-based decision-making tools into online platforms or at least within internal underwriting systems.
The excess and surplus lines should be able to provide such online access, he said.
Although given the diversity of the risks that enter this space, the challenge is greater and therefore, development in this arena, while not at all impossible, will probably require a longer gestation period than for standard lines.
A Competitive Environment
Bruce Kessler, division president, ACE Westchester, agreed that excess capacity in the market is making the insurance market more competitive in some lines.
E&S insurers “have to be really quick to adapt to a changing marketplace and use data to tell us what to do in addition to intuitive and experienced underwriting. … How we manage a portfolio and use data is never static.
“It’s generally hard to write new property business because at renewals, [the incumbent carrier] will take the business at a lower rate,” he said.
Casualty is also more challenging, he said, although not as fiercely competitive as property.
ACE Westchester continues to build out product in such lines as product recall, railroad, professional risk, private company D&O, life sciences, and allied medical services, he said
“While rates get more competitive, I think the results in those lines of business are still pretty good.”
Some structural changes as part of the ACE/Chubb integration — which is scheduled to close in Q1 2016 — will bring together ACE Westchester and Chubb Custom’s E&S businesses, which includes the wholesale sales and program business, he said.
“It will be a powerful platform, so we are excited about it,” Kessler said.
The integration overall, he said, is ongoing and complex, but “it’s a good match-up in appetite and product” and will allow the company to combine data and resources.
E&S in Transition
The E&S market is in transition, with significantly more competitiveness than in early 2015, said Vincent Tizzio, president and CEO of Navigators Management Co. Inc.
Nevertheless, while E&S will ebb and flow over the years, it has grown to about 7 percent of total property/casualty DPW in 2014, he said.
And in the 10-year period ending 2014, according to A.M. Best, surplus lines insurers grew from a 6.1 percent share of commercial lines DPW in 1994 to 13.9 percent in 2014.
“The death of the E&S marketplace has been predicted many, many times, said Jeff Saunders, president Nav Specialty, “and as many times as its demise has been predicted, it’s been reinvented or has evolved” by focusing on service, solutions, underwriting expertise and client need.
One way it needs to evolve again requires technological advances. Insurers need to use data, segment customers, enhance cost containment and offer a self-service approach to insurance, particularly for small to midsize businesses, Tizzio said, noting there have been some “nascent” advances in the commercial space.
“No one seems to have the special sauce to create technology solutions that aren’t rendered obsolete before they can be rendered,” he said.