Closing the Property Gap
A complaint is filed against your organization’s board of directors. The board did nothing wrong — but they’ll still need to be defended against the claims. The good news: You have a D&O policy in place to protect them. The bad news: It may not be enough.
Nonprofit organizations and private companies whose business is in or related to property may, in certain circumstances, be faced with the unpleasant discovery that there’s a chink in their D&O armor. That chink comes in the form of the property exclusion included in all D&O policy forms.
The property exclusion seems an innocuous enough passage. And it’s there for a valid reason: Property policies — not D&O policies — should cover property damage. D&O underwriters don’t want to get stuck paying for things they never agreed to cover. So the language used in policy forms is intended to address every possible angle. But there are instances where policy language can inadvertently go a step too far, excluding exactly the type of claims that organizations use D&O policies to protect themselves from.
The primary sticking point, as it is with any exclusion, is a matter of language. Consider this sample wording from one D&O policy form:
“Insurer shall not be liable for loss … for actual or alleged bodily injury, sickness, disease or death of any person, or damage to or destruction of any tangible property including loss of use thereof; whether or not such property is physically injured … .”
The language is pretty straightforward, and does what it sets out to do — it excludes any claim that alleges the directors and officers’ actions caused damage to property. Got damage? Look to your property policy. Case closed.
By contrast, consider the exact same exclusion as written on another D&O policy form:
“This insurance does not apply to any ‘loss’ or ‘defense costs’ in connection with any claim made against an insured, arising out of, directly or indirectly resulting from, or in consequence of, or in any way involving any actual or alleged bodily injury, sickness … damage to or destruction of any tangible property including any loss of use or slander of title … .”
On its face, that wording could be used to exclude just about anything related to property damage in any way, including common complaints that should trigger coverage, such as failure to set adequate reserves or failure to have adequate insurance. If those acts can be tied to property damage in any peripheral way, the carrier can refuse to defend the board.
Explained Mark Weintraub, insurance and claims counsel for Lockton’s southeast region: “If the board makes a decision — ‘OK, an elevator broke and we’re going to repair it’ — they know that’s part of the property damage exclusion. They’re not worried about that. But if it’s ‘we’re going to make a global decision about reserving funds … or a decision based on disclosures or assessments,’ that’s something that the property damage exclusion shouldn’t reach.
“There’s that danger for anyone who deals with property on a regular basis that the property exclusion could reach out and steal away coverage for basic fiduciary acts,” said Weintraub. “It’s not something that I think anyone intends, but it can happen, especially as claims get larger. Carriers will look at their policies to try and see what they can do to restrict coverage — that’s just human nature.”
Court Rulings Clash
A handful of cases brought the property exclusion debate to the courts in 2013, with mixed results.
In a Florida case, Commodore Plaza Condominium Association vs. QBE Insurance Corp., a building suffered damage during Hurricane Wilma. The property managers allegedly made multiple missteps after the fact, causing additional damage to the property.
The court held that all claims related to that damage were subject to the property damage exclusion — not a surprise. But the court also held that the exclusion applied to other alleged acts such as failing to provide security; breaching the duty to not interfere with peaceful possession of property; failing to follow all valid laws, zoning ordinances, and regulations; hiring unlicensed and unqualified workers; and failing to perform repairs in accordance with the Florida Building Code.
The court determined that the damage from the hurricane was the underlying cause of all of these alleged breaches and, therefore, they all fell under the property exclusion. And while there’s arguably some gray area, the court’s decision amounts to this: Not only are breaches of duty that result in property damage excluded, but so are breaches of duty caused by property damage.
The following month, an Illinois court offered a particularly troublesome decision in Hess vs. Travelers Casualty and Surety Co. The court, as might be expected, upheld an exclusion of coverage for an alleged breach of a duty to make repairs related to a construction defect. However, the court also excluded coverage for the failure to establish a reserve fund for repairs — an occurrence that took place years before the issue of property damage would even be raised.
“If a board is going to be second-guessed by its carrier for claims saying the board breached its fiduciary duty by levying an assessment, really — what are they paying for? What is going to be covered in the end?” —Mark Weintraub, insurance and claims counsel, Lockton
The decision whether or not to establish a reserve fund is clearly and wholly a fiduciary matter, and one related to economic harm independent from property damage. Put another way — the lack of a reserve fund cannot cause property damage. As such, it might seem that it should be cut and dried that a carrier would have a duty to defend an insured against a complaint that its negligent reserving decision led to economic harm. That is, after all, one of the points of having a D&O policy.
However, the court in Hess didn’t see it that way. It reasoned that the claim for breach of fiduciary duty arose out of, or originated from, the construction defect. Therefore, it fell under the policy’s exclusion language. The board, in this case, was left squarely between a rock and hard place. The complaint didn’t fall under the organization’s D&O policy — but it didn’t fall under the property policy either. Board members were left to their own devices.
A later case, Pulliam vs. Travelers Indemnity Co., also involved multiple complaints including failure to establish a reserve fund and failure to disclose conflicts of interest in a developer-controlled property owner’s association. In this case, however, the court diverged from the Illinois court’s interpretation in Hess, making a clear distinction between property and economic damage:
“The duty to establish a reserve fund, while related to the property damage, did not result in physical damage to tangible property as required by the policy. The failure to establish a reserve fund resulted in respondents having to expend more from their own pockets to make the repairs than they might have otherwise had to expend — economic damage. Likewise, allegations that [the board] breached its fiduciary duty … do not allege a physical injury to tangible property constituting property damage.”
Weintraub said he’s seeing a slight uptick in this type of friction with D&O policies. “I’m not saying this is some growing, dangerous trend, but I have seen it coming up more, and I see that these cases could give it additional steam because they have case law to rely on.”
Closing the Gap
In these cases, as with any related cases, the underlying truth is that none of the insureds ever expected to find themselves battling their policy coverage in court. They assumed they could rest easy knowing they had protected their directors and officers with a D&O policy if a complaint arose.
But sometimes just a few key words can get in the way. And that can have deeper implications for those whose lifeblood depends upon property. Consider this scenario: A property management group fails to maintain a roof on one of its buildings. The roof begins to leak and massive property losses follow. There’s no occurrence, so the property policy isn’t triggered. So the occupants turn to the board for relief and discover there are inadequate reserves set aside for repairs.
“That’s exactly what happens in the gap,” said Steve Shappell, managing director of Aon Risk Solutions’ financial services group. “We didn’t have an occurrence so we can’t go to our CGL, we can’t go to our property insurer because we didn’t trigger the cover, but [the claim] is clearly related to and arising out of property damage.
It’s not all that hard to see how the lines could blur further.
“If you take this out to the extreme, let’s say … a decision in the assessment world; that’s always unpopular in a condominium,” said Weintraub. “If an assessment is levied, usually your residents are going to be up in arms because it’s going to cost them money, so that usually leads to claims. And if a board is going to be second-guessed by its carrier for claims saying the board breached its fiduciary duty by levying an assessment, really — what are they paying for? What is going to be covered in the end?”
It’s How You Write It
On the surface, the solution is in the language.
“If you want to trigger defense, what you need to do with that policy language is strike the ‘alleged, arising from’ language and use the words ‘for,’ ‘from’ or other soft words that don’t have that kind of restrictive component to them,” said Monica Minkel, senior vice president of executive protection at Poms & Associates Insurance Brokers Inc.
But Minkel and others acknowledged that may be easier said than done.
“The quick answer is to say get rid of that language,” said Weintraub. “But sometimes that can simply be impossible.”
“The devil’s in the details,” said Shappell. “Can you get rid of it completely? If you buy an A side only policy — which is not very popular with the nonprofts and the private companies — you probably can get rid of the property exclusion, but it doesn’t make a whole lot of sense because it only covers non-indemnifiable scenarios and you’ve got to have a lot of cash to operate that way.”
Whether or not the language can be negotiated — deciding which elements of the policy are make-or-break — is a judgment call that brokers and insureds need to work out together.
“You could check 100 components, but are you going to move the business if eight of those components don’t match what you had before or they’re not the best you can get? Some carriers will negotiate and some won’t,” said Minkel.
That said, there are other considerations that will help ensure that a D&O policy responds, Minkel said. The first is whether a duty to defend policy form is used and the other is the cost allocation language.
“We’re looking for 100 percent predetermined defense cost allocation. What that means is if you get a claim in the door that has five causes of action and two of them are in a gray area or clearly shouldn’t be covered under the policy … they’re going to defend you for 100 percent of the claim, they’re not going to allocate the defense expenses based on covered and uncovered loss.”
Weintraub said it’s up to brokers to make sure that insureds understand what the property exclusion is and how it can lead carriers to deny defense.
“Awareness is half the battle. If they know a property damage exclusion could leap up and bite them when they’re not expecting it, then the key is to just keep that in mind when they’re making their decisions — especially with clients who are property managers,” he said.
That also means documenting decisions to make it clear that they’re not property related, he added.
“Directors and officers should be free to make fiduciary decisions and they should know what’s on the table and what isn’t as far as coverage goes ahead of time,” said Weintraub. “You don’t want it to be something of a gotcha.”
Accountability in the ACO Structure
Health care reform is reaching for some lofty goals: making sure every U.S. citizen who wants coverage gets it, increasing standards of care to produce better outcomes, and perhaps most importantly, reining in costs.
One way the Affordable Care Act (ACA) plans to meet its goals is by promoting the formation of accountable care organizations (ACOs). These systems — consisting of integrated hospitals, physician practices and outpatient medical facilities — aim to provide better quality patient care, increase efficiency and save money through care coordination and shared savings programs. An estimated 500 ACOs currently operate in the United States, serving as many as 30 million patients.
But the new structure changes the game for the health care industry when it comes to medical professional liability issues. Many factors come into play, including the hospital employment of physicians, new reimbursement models, higher standards of care and increased use of electronic health records.
As physician employers, ACOs “will need professional liability coverage for the errors of its professional care providers,” said Derek Jones, a principal and consulting actuary at Milliman.
In fact, said I. Glenn Cohen, co-director of Harvard Law School’s Petrie-Flom Center for Health Law Policy, Biotechnology and Bioethics, ACOs will see “an increase of malpractice liability at the institutional level.”
While liability will continue to fall just as heavily on physicians’ shoulders, plaintiffs will now be able to go after their employers as well for a bigger payout. Under the ACO structure, though, a physician employee might be forced to settle a lawsuit — whereas before she may have wanted to litigate the claim to protect her reputation — because the ACO’s top priority may be to limit losses.
Unlike managed care organizations (MCOs) that became ubiquitous in the 1970s and 1980s, ACOs are not afforded protection under the Employee Retirement Income Security Act (ERISA). Patients enrolled in MCOs were barred from filing claims of negligent corporate acts against the organization; they could not allege that a corporate policy was responsible for a physician’s malpractice.
In effect, ERISA shielded MCOs from liability stemming from their physicians’ errors and omissions as they pursued cost-cutting strategies.
Now, however, the Centers for Medicare and Medicaid Services website defines “corporate acts of negligence” as those corporate policies that may have influenced a doctor’s treatment decision, like a directive to meet certain cost-savings goals.
Meeting Higher Standards
At the same time, errors are likely to increase as physicians adjust to new demands, trying to both limit expenses and deliver higher quality care.
“If you’re going to incentivize physicians to achieve savings in the cost of health care, that could tempt them to provide less care, which could lead to higher claims,” said Mike Hollenbach, executive vice president of BMS Intermediaries. “But if you incentivize them with greater reimbursement based on positive outcomes, it could drive them to provide better care.”
The definition of “better” care matters. Traditionally, better care equaled more care — more tests and more treatments. While that may be a more comprehensive way to attack an illness or injury — as well as a defensive way to limit litigation risk — it results in a higher bill.
According to the CMS, health care spending, at $2.8 trillion or $8,915 per person, constituted 17.2 percent of the U.S. GDP in 2012. That’s about twice as much as other developed nations.
ACOs look to undo that trend, improving care quality by streamlining and coordinating services from all providers into one, patient-focused plan, and reducing unnecessary and redundant treatment. While limiting costs and delivering higher quality care should theoretically reduce malpractice claims, higher standards of care will likely introduce new exposures in the initial phases of health care reform. Until ACOs and doctors adapt to new demands and are actually able to deliver quality care at a lower cost, patients will have more ammo to bring against them in a malpractice suit, perhaps claiming “sub-standard” care.
Meeting higher standards will be complicated by a focus on “patient-centeredness,” another focal point of the Affordable Care Act. The ACA goes so far as to tie patient satisfaction to reimbursement. For example, Hospital Consumer Assessment of Healthcare Providers and Systems (HCAHPS) surveys, which poll discharged patients about their overall experience with hospital staff, are used as a quality measure to calculate value-based incentive payments, according to the CMS. Thus, patient satisfaction surveys have the potential to sway how “valuable” treatment was, which affects reimbursement.
The downside of those surveys is that they raise patient expectations for their next hospital visit. The survey doesn’t just ask patients about the adequacy of care received; it questions communications with nurses and doctors as well as the “cleanliness and quietness of the hospital environment,” according to the CMS. A surveyed patient may seek a more collaborative relationship with doctors and nurses and more pleasant overall experience, and could be more inclined to blame a problem on the lack of such an experience.
The influx of newly insured patients — estimated to reach as high as 30 million — will also make it more difficult to deliver that personalized attention. This could lead to a spike in claims.
Costs of Cost-Cutting
Corporate cost-containment goals and incentive-based payments present the biggest liability exposures, experts said. An ACA provision calling for value-based compensation that pays doctors based on positive outcomes rather than patient volume for Medicare and Medicaid patients is set to go into full effect in 2015.
“If certain diagnostic tests are reduced or eliminated, there is potential for failures to diagnose medical issues that would otherwise have been observed,” Jones of Milliman said. Patients who feel that cost-cutting attempts resulted in inadequate care can sue their physician as well as the organization that employs them, alleging negligence.
According to an article in The Journal of the American Medical Association, “medical liability claims would be judged by state standards, which do not consider federal cost containment goals when determining whether a medical decision was appropriate.” So adherence to cost savings guideliness may increase the the exposure of physicians or ACOs.
“I think this is the biggest concern at the institutional level in terms of liability,” Harvard Law School’s Cohen said. “I think they will want to make larger investments in managed care E&O insurance, to try to protect from that liability. They’ll also want to be cautious when implementing incentive-based compensation that is tied not to quality but to cost savings, because that will be fodder for plaintiffs that want to sue the ACO and claim that the ACO policy was responsible for their injury.”
Coordination of care also means increased reliance on electronic health records (EHRs). These records, containing not only medical history but also demographic and billing information, help doctors develop more personalized treatment plans and work together within their health network.
But they also create a document that could potentially provide more information that could be used against a health care provider in court.
“When you have a longer paper trail, there’s much more to find as part of document discovery,” Cohen said. If a physician deviates markedly from care that’s already been given, the EHR provides what Hollenbach of BMS Intermediaries, called a “roadmap to liability.”
“On the other hand, if they’re documenting very well, in conformity with practice guidelines and evidence-based care, that could be helpful in fighting litigation,” Cohen said.
Documentation that reveals no smoking guns would pressure plaintiffs to settle.
Discovery of negligence, however, is not the only liability threat that EHRs pose.
As more patient information becomes digitized, and more care providers gain access, physicians and health networks take on a huge cyber exposure. HIPAA violations will be all that much easier to commit, and any lost or stolen data could lead to massive claims. ACOs that require their physicians to use EHRs would be liable for securing and protecting that data.
The implications of health care consolidation for medical professional liability insurance could take years to be realized. If all goes according to plan, delivering care through an ACO should mean fewer claims but implementing change leaves room for error.
As physicians adapt to that change and learn how to meet higher standards of care, MPL claims could temporarily spike. Over the long run, though, “I think ACOs will see a net benefit in comparison to a similar group of physicians, hospitals, etc., that are not coordinated via the ACO structure,” Jones said.
Insurers will also have to adjust their products to fit new demands. As private practices get drawn into larger organizations, insurers that typically write policies for independent physicians will have to rethink their strategy, either by broadening coverage to include hospital-based risks or by carving out a niche among a small (and shrinking) customer base of independent practitioners.
For now, some insurers are anticipating that ACOs will need higher levels of coverage and are offering “package” policies that include MPL, D&O and general liability coverage.
Underwriters can also shift focus to mid-level care providers like nurse practitioners and physicians assistants, who will likely take on heavier workloads as more patients enter the system as new patients.
“We’re paying close attention to claim frequency. It’s the first leading indicator for whether future loss levels will change,” said Jones. “Given the lag from when errors occur to when suits are filed to when claims are settled, it will take a long time before we can really measure the impact of health care reform on MPL.”
“The insurers that will be the most successful,” said Hollenbach, “are those that can stay nimble and keep on top of these changes and react to them quickly and accurately.
What Is Insurance Innovation?
Truly innovative insurance solutions are delivered in real time, as the needs of businesses change and the nature of risk evolves.
Lexington Insurance exemplifies this approach to innovation. Creative products driven by speed to market are at the core of the insurer’s culture, reputation and strategic direction, according to Matthew Power, executive vice president and head of strategic development at Lexington, an AIG Company and the leading U.S.-based surplus lines insurer.
“The excess and surplus lines sector is in a growth mode due, in no small part, to the speed at which our insureds’ underlying business models are changing,” Power said. “Tomorrow’s winning companies are those being built upon true breakthrough innovation, with a strong focus on agility and speed to market.”
To boost its innovation potential, for example, Lexington has launched a new crowdsourcing strategy. The company’s “Innovation Boot Camps” bring people together from the U.S., Canada, Bermuda and London in a series of engagements focused on identifying potential waves of change and market needs on the coverage horizon.
“Employees work in teams to determine how insurance can play a vital role in increasing the success odds of new markets and customers,” Power said. “That means anticipating needs and quickly delivering programs to meet them.”
An example: Working in tandem with the AIG Science team – another collaboration focused on innovation – Lexington is looking to offer an advanced high-tech seating system in the truck cabs of some of its long-haul trucking customers. The goal is to reduce driver injury and fatigue-based accidents.
“Our professionals serving the healthcare market average more than twenty years of industry experience. That includes attorneys and clinicians combining in a defense-oriented claims approach and collaborating with insureds in this fast-moving market segment. At Lexington, our relentless focus on innovation enables us to take on the risk so our clients can take on the opportunities.”
– Matthew Power, Executive Vice President and Head of Regional Development, Lexington Insurance Company
Power explained that exciting growth areas such as robotics, nanotechnology and driverless cars, among others, require highly customized commercial insurance solutions that often can be delivered only by excess and surplus lines underwriters.
“Being non-admitted, our freedom of rate and form allows us to be nimble, and that’s very important to our clients,” he said. “We have an established track record of reacting quickly to trends and market needs.”
Lexington is a leading provider of personal lines coverage for the excess and surplus lines industry and, as Power explains, the company’s suite of product offerings has continued to evolve in the wake of changing customer needs. “Our personal lines team has developed a robust product offering that considers issues like sustainable building, energy efficiency, and cyber liability.”
Most recently the company launched Evacuation Response, a specialty coverage designed to reimburse Lexington personal lines customers for costs associated with government mandated evacuations. “These evacuation scenarios have becoming increasingly commonplace in the wake of recent extreme weather events, and this coverage protects insured families against the associated costs of transportation and temporary housing.
The company also has followed the emerging cap and trade legislation in California, which has created an active carbon trading market throughout the state. “Our new Carbon ODS product provides real property protection for sequestered ozone depleting substances, while our CarbonCover Design Confirm product insures those engineering firms actively verifying and valuing active trades.” Lexington has also begun to insure new Carbon Registries as they are established in markets across the country.
Lexington has also developed a number of new product offerings within the Healthcare space. The Affordable Care Act has brought an increased focus on the continuum of care and clinical patient safety. In response, Lexington has created special programs for a wide range of entities, as the fast-changing healthcare industry includes a range of specialized services, including home healthcare, imaging centers (X-ray, MRI, PET–CT scans), EMT/ambulances, medical laboratories, outpatient primary care/urgent care centers, ambulatory surgery centers and Medical rehabilitation facilities.
“The excess and surplus lines sector is in growth mode due, in no small part, to the speed at which our insureds’ underlying business models are changing,” Power said.
Apart from its coverage flexibility, Lexington offers this segment monthly webcasts, bi-monthly conference calls and newsletters on key risk issues and educational topics. It also provides on-site risk consultation (for qualifying accounts), access to RiskTool, Lexington’s web-based healthcare risk management and patient safety resource, and a technical staff consisting of more than 60 members dedicated solely to healthcare-related claims.
“Our professionals serving the healthcare market average more than twenty years of industry experience,” Power said. “That includes attorneys and clinicians combining in a defense-oriented claims approach and collaborating with insureds in this fast-moving market segment.”
Power concluded, “At Lexington, our relentless focus on innovation enables us to take on the risk so our clients can take on the opportunities.”