BEWARE THE CONVENTIONAL PRIMARY LAYER / UMBRELLA EXCESS “FOLLOWING FORM” STRUCTURE FOR GENERAL LIABILITY INSURANCE

New Trends in primary insurance terms may leave the company with NO insurance for major items, like defense costs, and excess carriers “following form” will be off the hook too

It used to be a safe and sensible way to go. Secure your primary (or “lead”) insurance with a deductible or self-insured retention (SIR) that matched your risk appetite, then attend to large losses with an umbrella policy above it, further burnished by a series of excess general liability policies atop the umbrella. The primary policy was necessarily complex because it also addressed the routine and frequent problems associated with auto liability and workers compensation. The excess policies were there to address the big general liability issues that might come along. It made a tidy package.

You could sleep secure in the knowledge that the umbrella and excess policies “followed form” to the underlying insurance, including the primary lead. So long as you did truly understand your primary policy, and so long as that primary policy actually spelled out favorable terms, your peaceful sleep was justified.

But recent trends in the terms of primary liability insurance have called this premise into serious question. Insomnia may now be the more appropriate state than happy dreams. Here’s why.

EXCESS POLICIES ARE ONLY AS GOOD AS THE PRIMARY TERMS THEY FOLLOW

We often find in our portfolio reviews that policyholders tend to focus on the importance of “follow form” protection from the top down. By that we mean that they view the feature of following form to be a safeguard working to their benefit, because it serves to prevent an excess carrier from issuing coverage that varies from the terms of the insurance beneath it. This is of course true. But it is also true that a policy that is following the form of policies beneath it will be only as favorable to the policyholder as those underlying policies are. And excess carriers will jealously guard their ability to rely on the restrictive terms of underlying policies—and without exception will specifically state that in no event or circumstance will they ever provide insurance that is broader than that provided below.

We believe companies should look at the “follow form” principle from the bottom up. In our view, nothing is more vital than the terms of the primary lead policy. Get that policy right first. Then lock in the identical terms above it.

ONE KEY EXAMPLE OF HOW SERIOUS POTHOLES IN THE PRIMARY POLICY, COMBINED WITH FOLLOW FORM EXCESS POLICIES, CAN DEVASTATE COVERAGE

Terms for defense costs

Primary liability carriers, for good reason, have become seriously concerned with skyrocketing legal fees and other litigation costs. They have pounded on law firms for lower and lower rates, but there is only so low you can go. So some primary liability insurers are now creatively transferring the responsibility for very large legal fees to the policyholder. They are doing this by getting companies to agree, normally in a lengthy endorsement to the policy, that even though the base policy provides a “duty to defend” the policyholder, the policyholder will pay ALL legal defense costs—even when those costs exceed the deductible or SIR—in any case in which no liability is actually paid. In other words, if you win, the whole legal bill is on your head, and none of it will be paid by the insurer.

Any general counsel will tell you that the expense of defeating a meritless claim can be huge. And most risk managers believe (and until recently have been usually correct) that the legal fee “bleeding” at least ends once the deductible or SIR is reached by the legal expenses.

This limitation on what was once accepted coverage also benefits the following form insurers who sit above.

And this divergence from the conventional notion of coverage for defense costs also results in a deadly minefield of conflict of interest in expensive, but flimsy, claims. If the merits of the claim look weak, but the depositions and extensive discovery needed to defeat it on summary judgment or at trial will run into the millions, the insurer, often controlling settlement, has an incentive to take it all the way, knowing that if the policyholder wins the case, it (the insurer) will pay nothing and the policyholder will pay the millions needed to achieve the good result.

SOLUTIONS

Many companies would be better off moving away from the conventional format of broad form primary coverage (for autos, workers compensation and the first portion of general and products liability), sitting beneath separately purchased umbrella / excess policies that follow form. By buying coverage for auto and workers compensation alone (for a reasonable premium driven by just those exposures), it can address all other operating and products liability with carefully worded policies. For example, if it is comfortable with an SIR of, say, $1 million, it can buy a lead general liability policy with a per occurrence limit of $15 million or more, and build into that lead policy optimal terms. It can then secure successive layers above it, to the total level it desires, and make certain that each follows the favorable terms of the first. Importantly, by breaking the general liability policies away from the complexities of the auto and workers compensation components, the GL program can usually be purchased at lower cost—sometimes very substantially lower cost. It is worth your while to take a fresh, independent look at the possibilities.

HOW “OTHER” IS “OTHER INSURANCE”? DON’T ALLOW YOUR GOOD WORK IN OBTAINING ADDITIONAL INSURED STATUS COME BACK TO BITE YOU!

Paying Attention to “Other Insurance” Clauses is More Important Than Some Realize

It’s always been a bugaboo to policyholders. An irritant. A pain in the binder—and other parts too. The infamous “Other Insurance” clause. Brokers and risk managers, including careful ones, tend to rush right past them without comment or notice. Simple boilerplate. As usual as night following day. Nettlesome but unavoidable. In the category of “Let’s just hope it never comes up!”

But the Other Insurance terms of your policies deserve more attention and—for policyholders—real concern. Especially insofar as they may relate to your status as an additional insured under another’s policy.

Back in the day…The original intent of “Other Insurance” clauses

In 35 years of reading commercial insurance policies, I don’t think I have ever seen one without a clause that, to one extent or another, attempts to defray the issuing insurer’s obligations to pay if “other insurance applies to loss that also applies under this policy”. Something there is that makes an insurer loathe to pay a loss that is also contemplated under different insurance.

And from the insurer’s point of view, the rationale for “Other Insurance” provisions is not unreasonable. The idea of “double recovery” a/k/a “double dipping” is plainly unseemly to many, including most courts that have not permitted it in the conceptually related area of subrogation recovery, where insured’s on occasion try to recover from their own first-party insurer and then again from the wrongdoer that caused the damage. Usually, the damaged party is required to offset its recovered insurance proceeds from the judgment subsequently obtained against the wrongdoer. The feeling just is that recovering twice for the same loss is somehow unfair, a windfall.

Maybe so. But the pendulum can swing way too far in the other direction too. Recently, we have begun to see some global liability carriers expand the reach of “Other Insurance” that will negate their own obligations to insurance under which the policyholder has been named an additional insured. This strikes us as patently over the top and inappropriate because it penalizes a company for doing what solid risk management advises: through reliable processes, make sure that additional insured status is obtained and properly documented from vendors, contractors, joint-venture partners and—in some rare cases—even customers.

These new provisions typically extend the “Other Insurance” benefit to the carrier by providing an expanded definition of what constitutes the valid and collectible other insurance that will, as a matter of contract, be deemed the first to respond to your loss. You guessed it: the new definition puts your status as an additional insured under a completely unrelated contract into that category.

Be especially wary of this new hook in your primary general liability policy. Since excess policies sitting atop the primary are “follow form” contracts entitled to rely upon and enforce the terms and conditions of the scheduled underlying coverage, this extension of “Other Insurance” refuge for the primary insurer will also provide safety to the excess layers above. And if you have worked to resolve a large claim penetrating one or several excess layers, you will likely agree with us that an energetic excess claims adjuster will optimize any provision below that is available.

You and your broker can address this. Just say no.

(If you are interested in reading more about the importance of additional insured status, and how to build a process for getting it regularly, see our September 2014 blog.)

WHAT THE LAW DEPARTMENT DOESN’T KNOW COULD HURT YOU

Risk Managers Will Benefit by Sharing Insurance Policies with Inside Lawyers

In most American companies, the insurance procurement and management function resides in the finance division, reporting up through the treasurer’s office and, ultimately, to the CFO. The legal department is normally not involved in the process, with the usual exception of the D&O liability insurance (because that particular policy often draws the interest of the CEO, board and CFO, who ask for legal review).

This characteristic is unfortunate. When management takes a step back to examine this isolation of insurance matters within the finance function, a few important questions emerge. Why are these complicated legal contracts not provided legal review, when countless other supply chain contracts, involving much less money, receive such review? If the legal function is expected to manage liabilities when they “arrive”, shouldn’t it be at the table when liability insurance terms are agreed to? What possible downside is there to more collaboration between the risk management and legal groups?

Interestingly, the separation of these two functions is pretty much an American fact that is not shared globally. In Europe, for example, (where the business insurance industry and profession is rooted in places like England, Switzerland, Germany and, more recently, Ireland), it is much more customary for the company legal department to manage and purchase insurance for the enterprise.

We do not suggest that companies should move the insurance management function lock-stock-and-barrel to the legal department. There is no “one and only” group that is uniquely suited for the role. But we do believe that all companies would benefit from increased collaboration between the risk management and legal functions; that the benefits can be large in terms of contract terms more favorable to the company and in correctly understanding as an enterprise what is and what is not covered by the contracts; and that there is no downside in any event to increasing the collaboration.

Just One Example: Treatment of Defense Costs in the General Liability Insurance Program

Even in large companies that ask us for an independent review of their insurance terms and program structures, we often find surprisingly adverse terms in the liability insurance as to who bears the burden of high defense costs in litigation matters. Too frequently, the legal group is under the impression that the risk management group has purchased insurance with a “duty to defend” the company, and that therefore the insurer will be handling the defense of cases by hiring law firms to represent the company, and paying them for their work. This is an understandable assumption. It is also nearly always wrong, unless there has been collaboration between the two groups in securing the liability insurance.

Where there has not been collaboration, we normally find that the contract terms require the company to pay all legal expenses and other defense costs in nearly all cases that are likely to occur, in addition to the expected “self insured retention” or deductible that applies to each and every loss, judgment, or settlement.

On the other hand, where there has been collaboration, affording the legal department the opportunity to negotiate with the broker and the insurance company, there will usually be much more favorable terms. For example, the expenses paid by the company for legal defense will often be applied toward the SIR or deductible, so that the company at least enjoys that benefit in return for paying them.

Take a case that settles for $250,000 after legal expenses of another $250,000. If the policy contains an SIR of $250K, and the insured must pay legal costs in addition to the SIR, the outcome is: company’s total loss=$500K; insurer’s loss= $-0-. But if the policy states that legal expenses paid by the policyholder apply towards the SIR, the outcome would be: company’s total loss $250K; insurer’s loss=also, $250K.

Given the chance to see this in advance, a law department will see the significance of this difference in a New York minute. And, clearly, the insurance producing the second outcome is much more valuable than that producing the first outcome.

In our experience, good insurance companies (and nearly all of them are reputable and well-run) welcome the involvement of the customer’s legal group in reviewing and understanding their insurance products. Like any other producer, insurers believe they are offering value, through many options, and they want their customers to properly understand what they are buying, and what they have chosen not to buy.

If your company is one of the many with a wall running between risk management and the law department, consider poking a hole through it and building a gateway. You won’t regret it.

PROPERTY INSURANCE POT HOLES

Avoiding Them Will Reduce All-In Costs and Improve Coverage Too

The cost associated with global property insurance is for most companies—especially manufacturers—the largest spend in the insurance portfolio, often comprising fully half of all insurance costs. Because of its complexity, it is also often the least understood in the C-suite. This is unfortunate since catastrophic property losses, and their concomitant business interruption/lost profits losses, are larger and more likely to happen to most global companies than a very large liability loss.

Why is it so unattended?

For one thing, global property insurance involves not one insurance contract, but often dozens, depending on the number of countries in which assets are owned or leased. The “paper challenge” alone is daunting. Once a “master policy” is decided upon and purchased in the United States, foreign counterpart policies need to be issued in nearly all foreign jurisdictions in order to comply with the laws and insurance regulations of those places, which normally require that a separate policy be issued “in country”, and that it comply with local insurance requirements as to terms, conditions, language, and taxes.

Second, the property policy is the least standardized in regard to terms and language of all commercial insurance. Property policies for large companies are truly “manuscript” policies with individually negotiated terms, conditions and endorsements. No two are alike, and even fundamental concepts can differ wildly from one policy to another, even when issued by the same insurer. And the policy will always be the lengthiest contract in the portfolio, perhaps exceeding 100 pages when amending endorsements are included.

Unintended consequences

For these reasons, we usually find very heavy reliance by companies on the judgments and decisions of brokers when it comes to the structure and terms of the property insurance program. While all of the brokers with whom we have worked have skilled personnel well connected to the many markets and want to do a good job for their clients, there are two common issues that crop up time and again:

  1. Brokers cannot possibly understand your varied global operating risks as well as internal managers and executives. And, importantly, they do not deeply understand the “profitability map” of the company—which sites are contributing what kind of profit stream to the overall entity. For example, it may be that several of your plants process and fabricate materials using expensive cutting equipment that incorporate precious metals for their functionality. Many insurers consider precious metals that are part of machinery to be “Excluded Property” altogether. You can be sure those plant chiefs are aware of this manufacturing fact. But is your broker, especially one located in India who is working as one of 20 from his organization procuring and placing foreign policies? And, we almost always observe anomalies in the reported values for estimated business interruption, which must be reported on a site-by-site basis for purposes of computing the policy premiums, both domestic and foreign. A CFO reviewing a list of reported values will surely note that something is wrong when a very small site, say in Malaysia, is listed as having a very large lost profits estimate equating to 20% of global EBITDA. But will the broker, who relies on what he has been told, often year after year, on a schedule that is really not carefully srubbed. (For every over-estimated dollar of lost profits, you are paying premium that you should not be paying.)
  2. Global brokers face global pressures—from within their own organizations and from the insurers. Inside their own firms, they are pressed to produce more placement activities for their foreign colleagues. For this reason, we are beginning to see large companies choosing to have their broker handle all of the foreign property insurance placement activities, instead of paying a modest “fronting fee” to a global insurance company to be responsible for getting all of the foreign policies issued and documented in an integrated global master control program, which they are well staffed around the world to do. In our experience, when the broker rather than the global carrier performs this administrative function, it in all cases results in much larger costs associated with the foreign policies. And it also may—and often does—result in the broker securing policies from other insurance companies, causing inevitable non-concurrency in terms and creating the possibility that the principal domestic insurer will not be responsible for a primary layer of property insurance purchased abroad from a different company that chooses to reject a claim.

The Solution

We find that companies that take the time to put a careful eye to the structure, content and costs of their global property insurance programs nearly always find important areas for improvement in terms and lower all-in costs. For companies with global premiums exceeding $3 million, these savings can approach 7 figures on an all-in basis (premiums, fronting fees, engineering fees, inspection fees, broker fees and commissions). An independent fresh set of eyes in this exercise can be a big help too, and is likely available to you for a very small percentage of your customary brokerage fee. Your internal risk or legal group, fortified by an independent consultant, can likely deliver immediate impact to the company’s bottom line by substantially lowering global insurance premiums and associated costs and fees.

Understanding The Available Insurance Is The Key To Settling A Liability Dispute

Getting to “Yes” requires dealing with the coverage issues that stand in the way

“What’s the problem here?”, the CEO demands to know. “They were wrong. They are liable. We should be paid for our damages. What is holding this up?”

The answer often is, “their insurance”.

More accurately, the answer would be: “They have insurance, but there is a dispute between them and their insurer as to how much of this is covered and who has to step up and settle the claim, and with whose money.” In other words, your valid claim is hung up in “insurance gridlock”—often honest internal debate—on the other side. Your CEO’s frustration is justified. But there are solutions.

Step One: Be Sure Your Recovery Expectations and Your Strategy Are Realistic and Aligned to the Insurance that May be Available—“Follow the Money” and “Be Careful What you Ask For”

Hopefully, your claim is against a well-financed company that can satisfy a judgment or pay a settlement whether it has enough insurance to do so or not. But if your claim is large and that other company is not, you may well face a situation where—realistically—you are settling with their insurer and not with them. The insurance is where the money must come from, because there isn’t enough money in the liable company itself to get you to settlement.

We are surprised at how often very able legal counsel for the plaintiff in a commercial case pays scant attention to this “fact of life”. Litigation strategies are often built around nailing down the liability of the defendant in as many ways as possible, but little thought is directed to “who is going to pay for the liability we prove?” A litigation approach that does not put a primary focus on understanding the insurance available to the defendant is, in our view, inefficient and maybe even counterproductive to full recovery.

First, the litigation expense that is run up in pursuing every alley of legal liability quickly erodes the net recovery obtained at the end of the day. But—even worse—your own work in establishing valid legal liability of the defendant may be just the demonstration the defendant’s insurer needs to validly deny coverage and shut off the funding needed for a realistic settlement. This is because you may develop facts, by asking for them or proving them in discovery, that walk straight into explicit exclusions in the insurance policies of the defendant—such as by showing that some conduct was intentionally wrongful, or may have occurred slightly before or after the stated periods of effective insurance, or a myriad of other possible exclusions, depending on the kind of insurance involved.

An independent insurance content expert can help you and your legal team to understand the fine print of the available insurance so that your litigation strategy is aligned with it.

Step Two: Deal Directly With the Defendant’s Insurer and its Coverage Advisor

We often find that the most valuable thing we can do for a company is speak directly—in a non-confrontational way—with the persons within the insurance company dealing with the available insurance question, and with the outside legal counsel on coverage that has usually been engaged by the insurer. These are not the same people that are working against you in the underlying liability case, and they will normally never personally encounter your own litigation team. But they are the individuals who will make what we call “the wallet calls”, and, most importantly, “how much money is in it”.

A settlement facilitator, such as Bauer Advising (or others!) can deal directly as non-combatants with these decision makers and influencers to discuss the nuances of coverage and move you towards a much prompter resolution.

Settlement facilitation is not the same as so-called mediation. It is a very different process in which the facilitator acts as an envoy moving between the parties and making proposals for settlement in an iterative process over—normally—60 days or so. The facilitator can be retained by all of the parties, some of them, or only one of them.

For a more complete description of how this process differs from mediation, see the article on this site dated January 6, 2015.

Why Early “Conventional” Mediation Rarely Works In Serious Disputes Where Insurance Funding Is Essential To Success

“Settlement Facilitation” is a better (and less costly) process. Here’s how it works.

Mediation has become standard fare in many liability disputes, including large claims in which it is clear from the outset that most or all of any ultimate settlement will be funded by available insurance of the defendant. And as more companies try to economize litigation, mediation if now often attempted early in the dispute, shortly after suit is filed—or even before. This “conventional” mediation has a standardized format embraced my outside counsel for all sides. It goes like this:

Counsel wrangles for a while on the selection of an agreed neutral, often a lawyer or former judge known to all of them. Once selected, the process that follows is normally the same: written position statements are prepared by all sides and submitted to the mediator, and probably shared with the other parties in some form.

If the defendant has applicable insurance, the defense position is almost always prepared by the insurers’ appointed defense counsel, usually at modest cost to the insurers who efficiently manage their appointees. The claiming party’s mediation efforts will normally be more expensive because its outside counsel is not laboring under the below-market billing rates imposed by insurers on their own appointed counsel.

On a given date, usually farther down the road than would be preferred by the claimant (on account of the inevitable scheduling difficulties), the disputants and their representatives meet in a formalized setting. The lawyers usually make opening statements, not unlike what happens in a trial. Then there is a lot of waiting while the mediator meets alone with each side, back and forth.

Attempted mediation of insured liability disputes will nearly always bear two trademark characteristics:

  1. The process is driven by lawyers for whom the coin of the realm is advocacy and combat; and
  2. The individuals most relevant to the decisions on insurance funding, the insurer’s coverage counsel (as opposed to the appointed defense counsel) and senior claims leadership, are either mere observers to the process or are disengaged altogether.
  3. Many parties do not appreciate that the insurance company sitting in the background of an insured liability claim is making two largely independent assessments, each of which is vital to its willingness to fund a settlement, and to what amount. The first is “what is our contractual obligation to our policyholder under the policy of insurance?”, for which it will, in large matters, have consulting outside coverage counsel with real influence. If its internal answer to this question is “not much”, the outlook for a successful mediation is slim to none. The second assessment is “How liable is our policyholder, what is its realistic exposure with or without our insurance?” Conventional mediations tend to be preoccupied with this second question, the answer to which is irrelevant if there is no insurance funding available to meet it. A big problem with early mediation of insured liability cases is that the players pertinent to the first question—how much insurance funding is available—are left out of the picture and seldom even in the room. The chair with the wallet is empty. And in large dollar disputes, that wallet—and its size—are fundamentally important.

    Standardized mediation can work in the right circumstances. For example, in small dollar disputes where liability is clear, no underlying coverage issue is present, and the only real question is measurement of damages. Or after years of litigation when “dispute fatigue” has set in, or an unhappy judge has scheduled a trial and the parties perceive it to be a true and firm date.

    But early in a dispute, and especially where insurance funding is involved and the underlying coverage is an open or disputed question, the mediation event involves much more lawyer arguing than dispassionate discussion. And the arguing is between individuals (appointed defense counsel versus claimant’s counsel) who will not be making the important financial and insurance coverage decisions anyway! Business executives who attend are disappointed and frustrated. A settlement is not reached. Time has been wasted, sometimes many months of it. And now, the real litigation expense will begin to mount, diminishing the net value of any future deal when it eventually comes.

    THERE IS A MORE SENSIBLE WAY TO EARLY SETTLEMENT, BUT IT DOESN’T LOOK LIKE REGULAR MEDIATION

    A principal focus of our work is insurance-related dispute resolution. As opposed to conventional mediation, we use a process we call settlement facilitation. It has three very different characteristics from ordinary mediation.

    1. The process is driven by “settlement facilitators” instead of counsel for the parties. The settlement facilitators have deep experience in the settlement of major claims and disputes, and understand the decision-making channels within policyholder companies and insurance companies because they had long careers in each. The settlement facilitators are not acting as counsel and are “non-combatants”. They may be retained jointly by the parties or independently. But in any case they are advocates for settlement, not for the correctness of any side’s particular positions.
    2. Instead of a formal meeting on a scheduled date, the process is highly iterative and incremental. The settlement facilitators work more or less daily, by phone, email, and in-person brief meetings with people on all sides of the dispute who can be helpful to settlement. Importantly, this includes frequent discussion with the senior level decision-makers within the insurance company (or companies) who will be looked to for ultimate funding of any agreement.
    3. Because the settlement facilitator is not serving as legal counsel to anyone, he is are able to reach directly in to management of all sides, and into the insurance company claims and business management at the senior level. (Legal counsel is prevented from doing this by lawyers’ rules which prohibit a lawyer from speaking with another party who is represented by counsel—so lawyers talk to each other, but not directly to the actual business decision-makers.) And, critically, the settlement facilitator or envoy can and will dialogue directly with the insurer’s coverage counsel to understand and discuss the insurer’s positions on the amount of available insurance.

    SPEED AND COST EFFECTIVENESS

    A credible settlement envoy can begin work immediately. Introductions and substantive, but friendly, discussions begin at once. There are no delays as large groups with competing schedules are not sought to be brought together. In fact, there may never be a formal meeting of the parties for the purpose of discussing settlement. Often, the first time the business players come together in person is to celebrate a settlement in a cordial setting.

    Even in complex matters with difficult insurance coverage issues to be ironed out, it is not unrealistic to expect a conclusion—usually a successful one—in 60 to 90 days.

    Bauer Advising acts as a settlement facilitator to all parties (or as an envoy for one of them) for a flat fee that is much less than would predictably be spent in legal fees to pursue and conduct mediation, not to mention the major costs to be incurred when that mediation is unsuccessful.

    There is a solution to every problem. Even the most complex insurance-related disputes are capable of settlement. The key is a realistic process that allows for progress “one step at a time”, and provides for communications between commercial decision-makers and experienced and credible envoys.

    Future posts will detail specific process steps and how you can implement them to obtain results—and obtain them efficiently and without rancor.

    Joe Bauer is the Principal of Bauer Advising LLC. Bauer Advising is an independent advisor and receives no commissions from any insurance company or broker, but assists policyholders, carriers, and brokers as settlement facilitators of disputed commercial insurance claims and related issues. Read more about Bauer Advising’s approach.

Does A Lurking Liability Worry Keep You Up At Night? Data Organization And Analytics May Be The Medicine You Need

For twenty years I served as the general counsel of a global company. NYSE traded. Eight thousand employees in 30 countries. Dangerous manufacturing processes. Our products and components were used in everything from wall coverings to transmission fluids; flooring to electrical cable; cosmetics to over-the-counter drugs.

I know a little about things that keep you up at night.

When will that next train derailment put us into the news and a dozen courthouses? What if that contract manufacturer fails again to follow FDA required quality control practices, triggering another recall? And other worries.

Now, as an advisor to companies on risk management, insurance content, and insurance dispute resolution, I’ve come to learn something I wish I had better understood when it was my job to worry.

It’s this: When you get a true grip on the data and information relevant to and influencing existing or nascent complex liability problems, you can understand and analyze it. You can realistically assess its scope and importance. You can know what to be concerned about, and what not to be so concerned about. Knowledge, secured through organized and digitized data, is more than power and might. It’s a good night’s sleep.

Let’s take an example

Your company uses Substance X in much of its manufacturing processes, and has been since the 1960s. Concerns about the toxicity of this substance were, at best, vague and unsubstantiated until the 1990s. But now it is clear that a small, but perceptible, percentage of persons exposed on a regular basis to this substance can be expected to develop a serious disease. So far, the liability problem has been manageable. A few suits were filed; a few settlements have been made. But what does the future hold?

This hypothetical company, whether it appreciates it or not, possesses historical information that, properly organized and interrelated, can provide it with realistic—and ongoing—analytic reports that will greatly clarify the true—from the imagined—potential risk it faces as an enterprise.

The usual approach and its shortcomings

Wise business leaders know that hope is not a strategy. When it comes to brewing liability problems, “wait and see” is not a strategy either. But far too many companies adopt it, because their professional advisors—usually a trusted law firm—really has no other strategy to offer. Litigators are good at litigating. When accurate information is available to them, they can assimilate, synthesize, and present it to fashion effective defenses. But litigators are neither forensic or technology experts. They need accurate information to do their job well, but they do not have the skill sets required to find, organize, analyze, and digitize that information in a relational database so that it can be used by them to most effectively protect the company. This is true even when “national coordinating counsel” has been engaged, and perhaps utilized for years.

So what usually happens? Matters are examined individually, usually by starting with cases that look particularly ominous. Cartons of miscellaneous records are plowed through by staff attorneys and coded for reference. But it is not realistic or economical to take a holistic approach this way. Most importantly, errors and unfounded presumptions will often be made. Many records will never be reviewed that should be, and many that are studied will be misinterpreted to mean things—good or bad—that are unwarranted when examined in the context of all of the data and the projections and modeling that can be performed on the basis of the entire picture.

It can be done much better, with real benefits

There is a much better way. A specialized resource with deep skills and experience with technology to capture miscellaneous complex data and build it into a relational database can work with your legal counsel. I call these specialists “liability data masters”, but the moniker is not important. The best of them combine strong accounting backgrounds with technology savvy and deep programming skills. These attributes allow them to analyze and report out the information from unlimited perspectives—geographically, demographically, sensibly. Whether you appreciate it or not, if you are a company with substantial legacy or ongoing liabilities, you are already paying somebody for an attempt to capture and use your information. You may be very surprised at what it will cost you to do it right, instead of the way it is being done for you now. And you will probably find that the benefits of your new ability to accurately forecast and understand trends—and report them competently to senior management to formulate moderate and long-term strategies, far outweigh any incremental increase in outside expense.

It’s not only about big liability exposures—the small stuff counts too

Even if your company does not face obviously serious exposures in the nature of mass torts, you can achieve important benefits and reduced long-term expense by expertly digitizing and understanding your information for more routine exposures. For example, if you have ongoing voluminous employment law matters because you have a large employee base, or unavoidably high numbers of parking lot liabilities, you will find that these expert resources can help you identify and address trends and much more accurately track and forecast future financial implications.

What is the value in knowing—and being able to prove through competently organized and reported data—that if future store locations are managed wherever possible by persons over the age of 50, employment law expense will be reduced by 50% for those locations? Or that, based on ten years of history and incident reports, parking spaces that are 12 inches wider result in 60% fewer injuries to customers and visitors in your locations?

It may just be a good night’s sleep. But it will also improve your bottom line.

Joseph W. Bauer is the principal of Bauer Advising LLC. For 20 years he was the chief legal officer of The Lubrizol Corporation, prior to its acquisition by Warren Buffett’s Berkshire Hathaway, Inc. in 2011. Now his firm advises companies on matters of risk and insurance management, and which facilitates the resolution of insurance coverage disputes. The firm also assists companies match outside resources to corporate needs in the effective management of risk and liability.

Careful Review of Business Insurance During Diligence Can Reduce Operating Costs on Day One For M&A Buyers

Even sophisticated buyers normally perform only a rough-and-ready assessment of the target’s commercial insurance arrangements in the diligence process leading up to closing. Most of the time, they are missing a chance to reduce operating costs on day one of their new ownership. And the cost reductions could be material.

For most companies—even small and middle market ones—the business insurance portfolio represents a significant cost. Especially for companies with substantial manufacturing equipment, the “all in” cost of the enterprise’s commercial insurance will normally be five to ten times the cost of all outside accounting and finance services, and will often exceed all legal expenses.

But in the M&A deal process, the quality and cost of the acquired company’s business insurance rarely receives a disciplined and independent assessment. Dealmakers and their counsel would serve their clients well by making sure that such a studied analysis is conducted and discussed in detail before closing with capable brokers and product specialists, including the target’s incumbent broker and an independent advisor. By rightsizing the insurance in place to meet the risk appetite of the new owner, and by taking a fresh look at the appropriateness of data driving premiums, savings generally will be in six figures for smaller companies, and will often reach seven figures for larger targets. Here’s why and how:

• What usually happens in diligence
The usual approach to insurance diligence is the compilation of a list of the various policies in place, accompanied by a summary of the most essential information from the policy declarations. This is normally prepared by the seller’s broker or the buyer’s broker (who may be the same), and is then reviewed by buyer’s counsel. The going-in assumption is that “insurance pretty much takes care of itself”. Nothing approaching the buyer’s financial analysis to scrub the quality of revenues or earnings is conducted. Questions central to the appropriateness of the target’s insurance—and its cost—are usually not asked. And if they are, the answers are rarely independently tested.

• Two examples of frequently overlooked opportunities
What, specifically, will a fresh look at the target’s insurance purchases produce? The likely opportunities for cost reduction and coverage improvement are numerous, but here are two areas that in our work almost always result in revised approaches at materially less expense.

  • Estimates of business interruption loss by location are too high, resulting in higher property insurance premiums
    For most companies, the property insurance program will be the most costly, usually accounting for at least half of consolidated insurance premiums. The premium charged for this coverage is computed from a base comprised of two sets of estimated values submitted by the target company. One set is the estimated cost to replace buildings, plant, and equipment at each of the company’s sites. The second set, known as the “business interruption” or “time element loss”, is the estimate of lost gross profits for each site, assuming a hypothetical disablement of that site for a stipulated twelve-month period. The sum of these two sets of values constitutes the “total insured value” against which the premium is computed. (E.g., if the estimated cost of replacing all of the company’s property and equipment is $500 million, and the total of all estimated business interruption loss is $500 million, the total insured value is $1 billion. If the insurance company has quoted a rate of $.12 (twelve cents) per dollar of insured estimated values, the annual premium will be $1.2 million.

    We consistently find that companies—large and small—tend to overestimate the amount of business interruption loss that will occur at many of its sites. It is not uncommon to find an estimate for a small manufacturing location equal to many times the historical EBITDA for that site. Or for a sales office to be listed with significant estimated profit loss. When this happens, premium is being paid for loss that can never be payable under the policy. In the example above, if the combined business interruption loss has been overestimated by $200 million, the target is paying $240,000 more in premium than it should be, assuming the quoted rate is appropriate.

  • Liability insurance disconnects with target’s loss history and the nature of its business
    The selection of liability insurance is normally driven by: 1) the risk appetite of the company purchasing it; and 2) the broker’s success in recommending specialty policies. More attention should be paid to the actual paid loss history of the target under the coverage in place. Nothing else is as telling as to the appropriateness of the liability policies. One good example is coverage known as “employment practices liability” (EPL) insurance. Many companies, perhaps including your target, have purchased it, especially in recent years. This coverage can add value to companies with large employment forces but very small legal departments. The policy acts more like a claims handling mechanism, than as true risk transfer insurance. In our reviews for companies, we usually find that these policies rarely produce a paid claim, because the self-insured retention (including for legal fees) is normally much higher than any historical paid claim, and the claims that present high cost exposures (such as claims under the Fair Labor Standards Act) are expressly excluded altogether. If paid claims over the past five years reflect less than 75 percent of the aggregate premium over that period (and you will find they often reflect 0-10 percent), you are looking at the opportunity to send real money directly to the bottom line.

Rethinking Deductible Strategies: Are You Stuck In The “Same Old, Same Old”?

When asked to comment on liability insurance policies, we are often struck by the deductible or retention structure we find, and it’s close cousin, policy premium. We see many financially strong companies with modest deductibles or retentions and the high premiums commanded by them. And we are often surprised at the limit purchased—usually it is lower than we would expect in a risk-sensitive company carrying a low deductible or retention.

Many companies go year-in and year-out with the same deductible structure. For companies with revenues between $500 million and $2 billion, we often see a general liability (GL) deductible of $250,000, and sometimes even lower. At renewal, a routine conversation occurs with the broker. Benchmarking data is consulted. The outcome is almost reflexive. Usually, the deductible stays the same, even as limit is increased. (It is remarkable how as companies grow, the amount of insurance purchased tends to increase more significantly than the retention or deductible.) And keep in mind that benchmarking data is merely a way of seeing what others are doing. It does not mean others are doing it right!

Get the CFO’s Insights

In most companies the CFO receives an annual insurance renewal briefing. But how often is the following proposition put to the CFO: “Our current retention is $250,000. We’re a fairly large company. Would it really be a serious financial problem to us if we suffered a $2 million loss in a given year?” In our experience, many CFOs will answer: “No. But I wouldn’t want two or three of them in a year.”

In other words, most CFOs look at liability risk in periodic aggregate terms. Repeated big hits must be insured against because they aggregate to serious consequences. But the rare, single big hit can be tolerated, as can routine lower value losses. Conventional thinking about retentions and deductibles, on the other hand, almost always looks at the risk in terms of per occurrence or per claim, with the same retained exposure for each and every one of them, whether it’s the first claim or the fiftieth in the policy period.

Where is it written that all SIRs and deductibles must attach or apply at the same level for all occurrences or claims? It isn’t written anywhere. It’s just the way it has nearly always been done, and, unfortunately, without enough linkage to the company’s true risk appetite or consideration of alternative structures.

We think “drop down” retentions (sometimes referred to as “corridor” retentions or deductibles) deserve much more attention than they receive, especially for companies without high frequency loss histories and good cash flow. A $1 billion revenue company with a good loss history and a per occurrence or per claim deductible of $250,000 or less, will significantly reduce premium cost by moving to a $2 million retention for the first (or first two) covered occurrence or claim in the policy period, with its original lower retention or deductible applying to additional occurrences or claims, should there be any to pierce it. For most good risks, there won’t be.

The Bottom Line:

There are ways to work from the CFOs appetite and look at deductible structure more creatively. And many CFOs will be pleased by the results. Why? Because by rethinking your deductible approach, the true concern of the enterprise—losses large enough to impair the balance sheet—can be protected, while the premium component, (the certainty component) of Cost of Risk (COR), can be reduced, or redeployed to increase limits, thereby meeting what should be the real objective: insurance against disaster. You may well find that by restructuring your deductibles, you can buy smart, and buy more, if you should be, for the same overall expenditure.

Two misconceptions about D & O coverage: what you don’t fully understand may really hurt you—unless you protect yourself

Publicly traded companies routinely buy Directors and Officers Liability Insurance (D & O), and even larger privately held companies are now doing so too. For good reason. In this country, we seem to have an inalienable right to be sued. And the leaders of corporations are increasingly prime targets of all manner of claims. No longer is D & O coverage needed to protect only against claims of serious breach of fiduciary duty in large mergers, egregious error in accounting procedures, or misleading disclosure of a major scale.

Nowadays, nearly every acquisition produces litigation against the target company, and sometimes the acquirer too. This is true even in relatively small value transactions. Even a modest stock price drop will generate threats of security fraud suits, or the actual filing of them. Additionally troubling is the emergence in recent years of large numbers of “unconventional” D & O claims that don’t involve securities issues, mergers, or the accuracy of financial statements at all. This new wave of litigation complains of mismanagement or gross negligence in environmental or other regulatory compliance, or even of employment practices and policies deemed offensive.

It is no wonder that outside directors, in particular, are sensitive to these exposures. So are senior executives, and they should be. Costs associated with D & O risk, including the settlement of essentially frivolous claims (which often include compensation to the plaintiffs’ lawyers) are an important and—for many companies—growing component of Total Cost of Risk (TCR). And when the big claim comes, and appears to have arguable merit, settlements are often large, in the tens of millions or even much more.

Despite its importance to the board and management’s interest in it, the practical application and fundamental terms of D & O insurance coverage are often misunderstood. These misunderstandings come to light when the large claim arrives. Tension in the c-suite, and sometimes embarrassment too, is the unfortunate and unnecessary result.

Other posts here will discuss additional pitfalls in D & O, but two common knowledge gaps are these.

1. How the Policy Limits Apply, and the Adequacy of the Amount of Insurance

A total limit of, say, $40 million for a company with $2 – 4 billion in revenue and a comparable or lower market capitalization, may seem on its face to be formidable. But is it? No director or officer enjoys $40 million in coverage available to himself or herself to protect their personal assets. (Many think they do, or that has been inferred to them.) That $40 million is shared limit, for all legal expense and settlement funding combined. And it is likely shared with quite a crowd. If there are 10 directors and 20 executive and so-called “Section 16 officers” in the company, you have 30 individuals sharing that limit. If one or more named insured is a “bad actor” with real exposure, and perhaps even fear of criminal liability on the horizon, the legal fees alone of such a person or group will substantially erode the limit and what is available for everyone else’s legal defense. And we haven’t even reached the question of how much will be needed to settle the claims.

A related misnomer is the belief that the adequacy of the D & O limit is rectified by the auxiliary purchase of a “Separate Side A” policy or policies. This kind of extra coverage is important, but it is not a substitute for adequate limits in the regular D & O program. This is because Separate Side A coverage does not apply to normal director and officer liability exposure. It only applies to non-indemifiable liability (or in the event insolvency prevents indemnification that otherwise would be available). The great majority of legal liability of D’s and O’s is indemnifiable under law and probably also under the corporation’s regulations, bylaws, or indemnification agreements—and therefore not payable under most Separate Side A policies.

The solution: get good independent advice and assessment as to your D & O limit. And remember that when you rely on benchmarking data, your decision is only as good as the limits reflected in it. If other companies are underinsured, and you rely on their decisions, you are climbing into the same boat.

2. Large Expenses Incurred to Prepare Your Defense and Document What Happened Will Not Be Covered Unless You Have Negotiated Special Terms

In our coverage claim settlement facilitation work, we have found a commonly recurring issue in which the company and its D & O insurer are immediately at odds. The company wants its substantial legal investigation and factual preparation expenses reimbursed, and the insurer says “no way”. This is not a small dollar issue.

The first instinctual response of most companies to a serious SEC or DOJ threat is to engage highly skilled legal defense counsel. A deep investigation is often launched immediately. Accounting professionals, even crisis management consultants, may also be engaged. Individual directors may be authorized by management to engage their own independent counsel, who in turn conduct their own investigations and prepare for the worst. We have seen claim evaluation and investigation costs exceeding $10 million as the threat continues to progress.

Companies are angry when their insurer informs them that none of these expenses (or a trifling sum provided for “early evaluation”, often as little as $500,000) are covered because such expenses are only covered after a formal “Claim”, as defined in the policies, has matured and been made against both the company and at least one individual named insured. And, unless you have taken the care to negotiate coverage with an earlier trigger of your right to reimbursement, you are in for a dogfight, without a strong position to argue.

This is especially important because in the usual SEC or governmental inquiry, the process begins informally with an inquiry or threat of possible legal pursuit. The government will normally do its work over many months, interviewing employees and gathering its evidence. It will begin at the bottom (and outside of the organization) and work its way up, saving senior-most executives and outside directors for last. It will not formally name an individual, such as the CEO or CFO, until the very end of its process. And by that time, your legal and accounting expenses may already be through the roof. But your policy may well state that a “Claim” has been made and is covered only when both the company and an individual named insured has been formally charged in a civil or criminal proceeding.

The solution: Understand your coverage and engage and direct legal and other defense resources accordingly and prudently, aware that this is probably going to be your money, and not the insurer’s you are spending. Better yet, get independent help and negotiate terms by endorsement—before any threat is made or known—with better coverage for these early defense and investigation costs.

Joseph W. Bauer is the Principal of Bauer Advising LLC. Bauer Advising offers independent help to companies in understanding an optimizing their insurance, and facilitates the settlement of large coverage issues. It also assists companies by matching insurance technology resources to risk management and claim management needs. For information on its Coverage and Gap Analysis offerings, read more here.