E&O Insurance
Welcome!
Welcome!
This course was designed to provide accurate credit hours for your state. It is not intended to be used as selling material, in part or whole, or to give any type of legal advice. Since this material is gathered from multiple sources, there may be differences of opinion stated or implied. In addition, laws and customs do change, so it is important to realize that facts and figures herein may also change.
It is understood by those who read this course for their credit hours that we expect each agent to be ethical in their dealings with us. This means that each agent must complete their own test without any help from another person or entity. We expect each agent to follow the guide-lines of their state.
All courses are solely owned by United Insurance Educators, Inc. No portion of the book may be copied or used for any other purpose than the one we intended: credit hours through United Insurance Educators, Inc. Thank you,
United Insurance Educators, Inc.
8213 – 352nd Street East
Eatonville, WA 98328 (253) 846-1155
Email: [email protected] www.uiece.com
E&O Insurance
Table of Contents
Table of Contents:
Chapter 1: Liability Dangers
Public Awareness: Page 1
Classified as a professional 2
Malpractice Insurance Policies 4
Standard of Care 5
In Summary 9
Chapter 2: General Liability
Industry Variety 10
Insurance Agents 11
Insurance Agents’ Professional Negligence 12 Insurance Agents’ Presumed Negligence 13 Insurance Agents’ Contributory Negligence 14 Insurance Agents’ Imputed Negligence 14 Insurance Agents’ Negligence in Tort Liability 15 Express Authority & Ostensible Authority 17 Torts & the Basis for Liability Claims 19
Torts & Contracts 20
Liability Under Torts 20
Insurance Agents’ Civil & Criminal Violations 20 Insurance Agents’ Breach of Contract 22 Breach of an Implied Agreement Theory 23
Breach of Contract Theory 23
Legally Binding Insurance Contract 23
Relevance 24
A Contract of Adhesion 24
For Review: 25
Accountant’s Liabilities 25
When Are Accountant’s Not Liable to Third Parties? 26
Accountant Negligence 28
Accountant Breach of Contract 29
Accountants’ Civil & Criminal Violations 30
Investment Advisor’s Liabilities 30
Stockbroker’s Liability 32
Stockbroker Negligence 33
Stockbroker Breach of Contract 34
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Table of Contents Chapter 3: Preventive Measures
Public Harm 37
Triggers 37
Financial Planning in the Real World (risk) 38
The Degree of Risk 42
Inflation 42
Likelihood of Loss 45
Degree of Loss 46
Risk Classifications 47
Who Should Carry the Burden of Risk? 49
What Type of Documentation? 51
Claiming Unearned Education or Experience 51
Full Disclosure 52
Release of Liability Form 52
What Is Due Diligence? 54
Fiduciary Duties 55
Keeping Current on New Trends 56
Chapter 4: The Policy
By Any Other Name . . . 58
Claims-made & Occurrence policies 60
Insurance Agents 63
Financial Planners 64
Chapter 5: Professional Ethics
Industry Ethics 65
Personal Ethics 66
What Are Ethics? 66
Virtues 68
What Motivates Ethical Behavior? 70
Egoists 73
What Are Our Responsibilities to Other Moral Persons? 79
Establishing Our Identity 80
Objectivist Ethics 81
How Can One Be Ethically Active? 82
Laws and Ethics 88
United Insurance Educators, Inc.
8213 – 352nd Street East
Eatonville, WA 98328
E&O Insurance
Liability Dangers
Chapter 1
Liability Dangers
Public Awareness
More and more people today have become increasingly aware of their legal rights. There are many reasons for this increased awareness. For one thing, there are more articles published in newspapers, magazines and periodicals about common legal problems a person may face. In addition, there are television programs dealing with many legal issues. To add to this we have lawyers advertising their services. The result of this available information is somewhat knowledgeable consumers who are more likely to sue someone if their service or product does not fulfill the consumer's expectations. Many of today's consumers are ready to go to court at the slightest dissatisfaction resulting in a number of groundless and frivolous lawsuits. We could say this is a negative result of increased knowledge and even term it as a "sue happy" society. Even so, there is a positive side of increased public awareness. This willingness to sue when dissatisfied is good since the so-called "little man" is no longer being intimidated.
Professionals often feel that they do such a good job that they are immune from the threat of lawsuits, but that certainly is not the case. The 1970s saw the beginning of the trend to sue professionals for negligence or malpractice. The definition of a professional was broadened in the 1970s to include not only doctors and lawyers, but also architects, engineers, accountants, stockbrokers and insurance agents. It also expanded the definition to include such diverse groups as real estate agents, management consultants, crop dusters, data processors, printers, employment counselors, translators and telephone answering services. In this text, we will refer to all of the above professions as "professionals."
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Perhaps the newest professional field to be classified as a profession is that of financial planning. Along with the benefits of being recognized as a profession comes the burden of stricter standards of conduct. This also increases the chances of being sued for malpractice. If the financial planner performs poorly in the mind of his or her client, a lawsuit can definitely result. This makes the financial planner especially susceptible since views of good and poor performance are often hard to verify. Clients are very skeptical about any loss of money regardless of whether or not the financial planner acted in good faith.
The financial planning industry, on the whole, has very few guidelines for avoiding malpractice suits. We would hope that all financial planners have a code of ethics, of course. Being personally ethical, however, is not guaranteed protection. There are various organizations, such as the International Association for Financial Planning (IAFP) and the for Certified Financial Planners Board (formerly IBCFP), that have published codes for financial planners to follow. In fact, the CFP Board has continuing education requirements for their agents, specifically requiring two hours in an approved course dealing with their Code of Ethics and Standards of Practice of the International Board of Standards and Practices for Certified Financial Planners. The individual codes published by these organizations provide ethical guidelines, not rules of law. Lawyers have been guided by years of numerous legal cases to which they can refer in order to help determine a course of action along with their detailed code of ethics. The longer the financial planning industry exists, the more guidelines the financial planner will have in terms of more case law, established precedents and definitive regulations.
Initially only a few states required ethics as part of their continuing education requirements but that is no longer true. Currently the majority of states require some type of ethics as part of the total continuing education requirement. Requiring ethics as part of the total CE requirement does not mean the insurance departments believe their agents are unethical; rather it is an attempt to emphasis the importance of ethical behavior.
The 1970,s saw the definition of professional broadened to include accountants, stockbrokers and insurance agents,
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Even without established legal precedents and definitive regulations, it is still possible for a financial planner to take affirmative measures to avoid a malpractice suit. The most obvious and important key is awareness. Through this awareness, an insurance agent or financial planner can achieve a set of standards by looking at the standards of care required by other professionals, particularly those professionals who comprise the majority of the financial planners today. These would include insurance agents, insurance brokers, accountants and stockbrokers. Since the financial planner’s duties often include many of the responsibilities of these professionals, looking at how the courts have treated their cases can be helpful.
This acquired awareness would also include understanding and knowing the duties of a financial planner. A financial planner seldom wears “one hat.” Rather he or she is also an insurance agent, a tax advisor, a retirement advisor, and an estate planner. The financial planner must always be conscience of what role they are currently playing in order to avoid any potential conflicts of interest. For instance, an insurance agent/financial planner has to be careful not to recommend excessive life insurance. If his or her recommendations appear excessive or inappropriate it could be viewed as self-serving (to obtain excessive commissions, for example). On the other hand, if too little insurance is recommended, this could be considered negligence. At all times, it is important for the insurance agent/financial planner to document why such recommendations have been made. These documentations should be dated and kept in the client’s file. In past years we have also seen a rise in the number of larger judgments being awarded to plaintiffs who brought suit against professionals. Not only were courts awarding judgments in excess of the professional's insurance policy limits, but punitive damages were being awarded as well. Normally the courts motivation behind punitive damage awards is to punish the wrongdoer. It is questionable whether punitive damages can be paid out of an insurance policy's fund. However, since punitive damages are awarded only in cases where punishment is required, a financial planner has hope of avoiding this if he or she tries to adhere to industry guidelines and does not intentionally do anything illegal or improper. As stated, documentation of all financial recommendations is extremely important.
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Many financial planners believe they will be sued for malpractice at least once in their professional career. Therefore, two issues must be addressed:
1. What can a financial planner do to try to avoid a malpractice suit? 2. What should a financial planner do to mitigate the harm of a
malpractice suit if one is filed?
If a malpractice suit is filed, it does not necessarily matter whether or not the professional is found innocent. The harm to the professional is simply the filing of the suit and the publicity that nearly always comes with it. Many people may know of the malpractice suit and yet not many will know if the professional is found innocent. Damage to the professional's reputation has occurred. To add injury to insult, it is a time-consuming process to be involved in a malpractice suit. During that time, the professional may lose clients simply because they are the target of such a lawsuit. The numerous hours spent in court and giving dispositions will take the professional away from work and result in further decrease in productivity and thus, income. Of course, there will be legal fees as well.
Malpractice insurance policies also referred to as Errors and
Omissions insurance or E&O insurance will be discussed in a later
chapter, but it needs to be mentioned because this type of policy contains a unique settlement clause in favor of the insured. With typical professional liability insurance, the insurer (insurance company) cannot settle a claim without the insured's consent. In typical property and casualty insurance policies, the insurer is given the right to settle the claim in whatever fashion they feel is reasonable. Because the professional's reputation is involved it is important that a suit not be settled if it lends further damage to the individual’s future. Any settlements made on behalf of the professional could be construed as an admission of guilt. Even with this provision, however, the majority of claims against professionals are settled rather than taken to court. This is true because of the time and expense involved in litigation, the adverse publicity that accompanies a lawsuit and the negative
With typical professional liability insurance, the insurer cannot settle a claim without the insured's consent.
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effect the suit can have on the professional's practice. Many professionals opt to settle a claim against them, whether it is valid or not, rather than experience the above stated consequences.
Standard of Care
One of the first steps to avoiding a professional liability lawsuit is to understand what is required of a professional when dealing with a client. In legal terminology, the professional should know the applicable standard of
care owed to a client.
A claim based on liability imposed by law develops as the result of the invasion of the rights of others. A legal right is more than a mere moral obligation of one person to another, for it has the backing of the law to enforce that right. Legal rights impose many specific responsibilities and obligations. Some of these are quite obvious in a general sense, such as not invading the privacy or property of others or not creating an unreasonable risk or actual harm to others.
The invasion of legal rights is a legal wrong. The wrong may be: 1. criminal (public), or
2. civil (private).
A criminal wrong is an injury involving the public at large and is punishable by the government. The action on the part of the government to effect a conviction and impose fines or imprisonment is termed a criminal action.
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Civil wrongs are based upon: 1. torts, and
2. contracts.
Torts are wrongs independent of contract. Examples of these would include false imprisonment, assault, fraud, libel, slander and negligence. Contracts may involve legal wrongs when applied to warranties which are violated, bailee responsibilities which are not fulfilled or contract obligations which are breached.
For liability insurance, the emphasis is on civil wrongs and particularly on the many legal wrongs based upon torts. Of the greatest importance are torts resulting from negligence (unintentional acts or omissions).
Torts include all civil wrongs not based on contracts. As such, they are a broad residual classification of many private wrongs against another person or organization. They occur independently of contractual obligations and may result from:
1. intentional acts or omissions,
2. strict liability imposed by statute law, or
3. negligence.
Negligence is the failure to exercise the proper degree or standard of care required by circumstances.
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We are going to concentrate on the negligence portion. Negligence is a tort; a civil wrong not based on a contract. Most of the liability imposed by law stems from accidents attributable to negligence. If negligence can be shown to be the proximate cause of an injury or loss to another, the negligent party is liable to the injured party for damages. Negligence is the failure to exercise the proper degree or standard of care required by circumstances. It may consist of not doing what is required under the circumstances, or doing something that ought not have to have been done.
Behavior in any circumstance which fails to measure up to that expected of a careful, prudent person in like circumstances constitutes negligence. Faulty
judgment may result in liability for negligence, even though the motive behind the act was the best.
In an ordinary negligence case (not involving a professional), the standard of care required of the defendant pivots on the questions of whether or not the accused behaved as "an ordinary reasonable prudent person" would have behaved under similar circumstances. In addition, the defendant is required to use any special knowledge they may have obtained through education, training, or experience. This obviously affects insurance agents, since they have received special training and education and probably have some type of experience as well.
In regards to the professional, the required standard of care changes. If a person offers professional service to the public, it is presumed that the person possesses some degree of special skill and knowledge. Unlike the ordinary negligence cases, where special skill and knowledge is considered only if the accused in fact possesses it, a professional negligence case imposes a certain level of skill and knowledge on the defendant whether or
not they actually possess that skill or knowledge. Anytime an individual
displays any assumption of professional skill, it is assumed to be real. This would include such things as having business cards printed which read “financial planning.” Having such cards printed indicates training, education, or experience. It does not matter whether or not the individual actually has any training, education or experience. It will be assumed that he does. It is
Behavior in any circumstance which fails to measure up to that expected of a careful, prudent person in like
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profession stated. Since this standard of care applies to the profession stated on the business card, in a lawsuit the individual will be expected to have performed to the level of that profession. That is why it can be very dangerous to allow clients to assume training, education, or experience that does not actually exist.
Since just about anyone can claim to be a financial planner, it may hard for the average person to know if one is qualified or not. There has been much attention given to this matter by individual states requiring specific knowledge of those who profess to be financial planners. However, with the development of the IBCFP and IAFP's Registry, along with the movements by individual states, this is changing. With increased regulation of the financial planning industry, the states are attempting to clarify who can and who cannot make such claims. The lawsuits against financial planners will likely increase as well, encouraging the establishment of legal precedents. Attorneys now have the option of attending classes on how to sue insurance agents and financial planners. It is something that every agent should consider before stepping into dangerous situations.
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In Summary
• The definition of a professional was broadened in the 1970s to include not only doctors and lawyers, but also architects, engineers, accountants, stockbrokers and insurance agents.
• Malpractice insurance also referred to as Error and Omissions insurance or E&O insurance are a type of policy which contains a
unique settlement clause in favor of the insured. It does not allow the insurer to settle a claim without the insured's consent.
• Torts are wrongs independent of contract. Negligence is a tort, a civil
wrong not based on a contract.
• Negligence is the failure to exercise the proper degree or standard
of care required by circumstances.
• A professional negligence case imposes a certain level of skill and knowledge on the defendant whether they actually possess that skill or knowledge. This is a standard of minimum professionally acceptable conduct.
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General Liability
Chapter 2
General Liability
Industry Variety
The financial planning industry has one characteristic that is unique to this industry: its members come from a variety of other industries. Financial planners can be accountants, stock brokers, or insurance agents. It may be possible to predict the future treatment in the professional liability field by looking at the treatment of these various professions. We have also seen the banking industry go into the financial planning field, as well as other in-dustries not otherwise considered a financial planning field.
This chapter will primarily focus of the three professions from which the majority of financial planners come. This would include insurance agents, accountants, and stockbrokers. The financial planner’s duties often include many of the duties of these professionals. Looking at how the courts have treated these professionals can help us determine how the financial planning field will be treated by the courts. It is particularly relevant since the duties of an insurance agent, for instance, parallels those of a financial planner - preparing and analyzing financial statements, determining risk exposures, determining adequate insurance amounts, investing the client’s money, and planning the client’s retirement and estate planning needs.
In recent years we have also seen cases establishing a standard of care for investment advisors. Certainly financial planners would fall into the category of investment advisors, as do some insurance agents. Looking at these cas-es also offers a means of predicting how a financial planner will be treated in court.
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Insurance Agents
Insurance agents are in the ranks of other professionals in the quest for risk avoidance, which means that liability insurance is a must. Physicians have had to pay plenty over the last years for professional liability insurance. Attorneys joined physicians as liability risks, followed by accountants, then insurance agents and financial planners. Insurance agents are further faced with limited liability insurance coverage and increasing premiums. Add to this the national awareness about potential liability risks, making clients more apt to litigate in the event of a mistake on the part of the insurance agent. It is safe to say that liability insurance is a necessary part of doing business for insurance agents, just as it is for physicians and attorneys.
As we stated, there could be a conflict of interest for an insurance agent who is also a financial planner. The two roles need to be separately matained to some degree. Of course, all
in-dustries who deal with finances must con-sider how the various roles interact. The insurance agent who is also a financial planner will want to market their services, but each type of service must be correctly handled. The ethical standard in these circumstances must always consider the client first and commissions second.
We could use the example of a young family, both parents are age 26, with one child, age three, who comes to an insur-ance agent/financial planner wanting life insurance. It is determined that the fami-ly needs at least $250,000 life insurance coverage. However, the family cannot af-ford the cost of a whole life policy. Should the insurance agent sell them less insur-ance coverage and receive higher com-missions? Or should the agent sell the family a less expensive term policy cover-ing the family the way the financial plan-ner saw fit? Naturally this potential con-flict of interest exists for the insurance agent who is not a financial planner, but
Liability of Agents
What an agents says in terms of “puffing” or exclaiming the virtue of a policy is often not actionable except in the cir-cumstances where an agent assumes additional duties, has a special relationship of trust with the buyer, or holds him-self/herself out as having spe-cial expertise. Then a spespe-cial duty arises. But when an in-surance agent gives asin-surance of proper coverage and it turns out to be false, that agent will be held liable for negligent misrepresentation. That is not to say that an in-sured can remain intentionally ignorant of the terms of a pol-icy. An insured is not required to independently verify the ac-curacy of representation made by the agent regarding the policy and an agent can be held liable for intentional or negligent misrepresentation.
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for the agent who is also a financial planner since their primary function is not to sell a product but to provide financial advice. Some industry people feel consumers should seek out a financial planner that does not sell prod-ucts of any kind; they merely advise consumers.
Insurance Agents’ Professional Negligence
Conflict of interest is one of many professional liability problems facing in-surance agents or brokers. They, like other professionals, can be found lia-ble for negligence, violation of a statute, and breach of contract.
Negligence is the broadest field of exposure for an insurance agent. Negli-gence is a tort - a civil wrong not based on a contract. NegliNegli-gence is often the result of carelessness, thoughtlessness, forgetfulness, ignorance, or just plain stupidity. It involves errors and omissions made by the insurance agent. The majority of the liability imposed by laws stem from accidents de-rived from negligence. If negligence can be shown to be the proximate cause of an injury to another, the negligent party is libel for the injuries or damages sustained. We tend to think of negligence and damage to others to be physical, but financial damage is also possible. Negligence could be defined as the failure to exercise the proper standard of care required by the circumstances. Negligence never involves intent. A negligent act may in-clude not doing what was required under the circumstances, or doing some-thing that fails to measure up to what would be expected of a prudent per-son in like circumstances. Faulty judgment may result in liability negligence, even though the motive behind the act was purely innocent. This point is very important when it comes to anything financial. A financial loss does not necessarily mean faulty judgment; no one has a crystal ball when it comes to investing. However, if the advice given is indeed found to be faulty, then a malpractice lawsuit is possible.
Negligence is the broadest field of exposure for an insur-ance agent.
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There are laws that require all persons to use prudence in their actions so that others will not suffer bodily injury or property damage. Failure to heed such prudence gives the injured party a right to action against the negligent party for damages. “Prudent behavior” is based upon what society expects of the individual. The conduct must be reasonable in light of the risk in-volved.
Insurance Agent’s Presumed Negligence
Ordinarily the burden of proof lies on the plaintiff (claimant) in a negligence case. The plaintiff must prove that the defendant failed to exercise the rea-sonable standard of care for a prudent person. However, this may not al-ways be the case. If the facts presented justify a reasonable form of judg-ment of negligence, the courts may lift the burden of proof requirejudg-ment by applying the common law doctrine of res ipsa loquitor (meaning the thing speaks for itself). Negligence is presumed without the plaintiff having to
prove it. The burden of proof is then shifted to the defendant. Under this
law a legally sufficient case of negligence can be established and referred to the jury if the:
• plaintiff’s injury was caused by a defective object,
• injury could not have occurred without the defendant’s negligence, and
• object causing the injury was controlled by the defendant. These conditions establish presumed negligence.
The law of presumed negligence applies when an accident causes an injury preventable by the use of prudent care and/or safety inspections. Presumed negligence has been applied to a number of accidents which occurred with-out witnesses: railroad or aviation injuries, medical malpractice claims, and/or damages from defective products for example. The last example of product liability has some difficulty applying res ipsa loquitor in the courts. That is because the claimant, not the defendant, controls the product. The control of the product lies in how it was used: properly or improperly. How-ever, the courts have held defendants in control of the product if it has not been changed since leaving the manufacturer. The courts are not consistent with these decisions, though.
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Insurance Agent’s Contributory Negligence
When negligence is presumed, the plaintiff must not be guilty of
contribu-tory negligence. The circumstances of the accident must be
unquestiona-ble as to the negligence. If the accident could be caused by any other means the res ipsa loquitor law is not applicable. Presumed negligence does not exist if the accident results from circumstances beyond the control of the defendant. The accident must be such that the injury could not have oc-curred ordinarily without the negligence of the defendant. An accident re-sulting from a third person’s involvement or from any physical or mechanical action is also not applicable.
Insurance Agent’s Imputed Negligence
Imputed negligence makes an individual responsible for negligent acts of others. Employers may be liable for the action or negligence of their em-ployees, as well as the employees themselves. If an employer uses inde-pendent contractors whose employee negligently causes an injury, that em-ployer could be held liable if it provides faulty instructions or tools. Imputed negligence can occur even to unaware individuals. Landlords whose tenants cause an injury from a negligent act could be held liable. Parents could be held liable for the actions of their children.
Vicarious liability laws impute liability to automobile owners even though they are not driving or even riding in their cars. Even if the car was bor-rowed by a friend, the owners of the vehicle could still be liable for the ac-tions of the driver. Under the family purpose doctrine liability applies particularly to the automobile owner whose family members negligently use the car.
Although presumed negligence may not apply if a third person is involved in the negligent act, imputed negligence does apply to third persons who may not be directly involved.
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Insurance Agent’s Negligence in Tort Liability
Where allegations of negligence are made, lawsuits present major issues in tort liability.
There are typically specific things which must apply:
1. Before a court will award damages for negligent liability to a plaintiff, four requirements must exist. They are:
a) a legal duty to protect the injured party, b) a breach of that duty or wrong,
c) an injury or damage to the plaintiff’s person, property, legal rights or reputation, and
d) a reasonably close proximate relationship between the breach of duty and the plaintiff’s injury.
2. Defenses in a negligent action.
Since there are never absolutes, a plaintiff may prove all four elements (legal duty, breach of duty, the injury and proximate relationship) of a negligent act and still not be awarded damages. The defendant has sev-eral successful defenses available. Two principal ones are:
a. contributory negligence, and b. assumption of risk.
Contributory negligence means that the plaintiff is also negligent and that negligent action contributed to the loss incurred. If the plaintiff is guilty of contributory negligence, they may be denied damages. Con-tributory does not relieve the defendant of duty to the plaintiff. Instead, it denies the award of damages to the plaintiff if both parties are at fault. In a strict sense, the doctrine of contributory negligence does not al-ways produce equitable results. A slight degree of responsibility, (negli-gence) on the part of the plaintiff could result in no award of damages. There are two substantial variations of contributory negligence rules:
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a) comparative negligence, and b) last clear chance.
Under comparative negligence, the court, often the jury, attempts to scale or diminish in proportions the awards according to the comparative degrees of negligence of the parties involved. Not all states have com-parative laws. Partial comcom-parative negligence statutes are more common.
Under the last clear chance doctrine, the defendant is able to prove that the plaintiff had the last clear chance to avoid the accident. The last clear change doctrine states that the defendant with the last clear chance to avoid the accident is guilty of contributory negligence by failing to avoid the accident. If both the plaintiff and defendant were inattentive, this doctrine does not apply.
3. Statutory modifications of the common law on negligence.
The most common type of negligence for insurance agents is failure to place necessary insurance, failure to obtain proper coverage, failure to properly advise of the company’s rejection or lack or coverage, failure to cancel a policy at the insurer’s request, and failure to fully disclose the na-ture of the risk. In addition to this, the agent may be liable for giving unau-thorized instruction to insureds or unauunau-thorized interpretations of coverage, delaying the underwriting or claim information, or binding an unacceptable risk.
We can look at some examples of an agent protecting themselves from a liability claim by informing the client of their options completely. Many property and casualty agents are expected to mention the availability of
umbrella liability insurance when they are selling an auto or homeowners
policy. This is not done for the purpose of receiving higher commissions. Umbrella liability policies do not offer the agent particularly large commis-sions. The agent who does this is doing it to protect themselves in the event that the insured suffers a loss greater than the amount of liability protection provided under the auto or homeowners policy. By informing their clients of the option of buying more liability coverage, the agent is preventing the in-sured from filing a suit against them for failing to provide adequate cover-age. Of course, this insurance offer should be documented, perhaps even obtaining a reject signature from the consumer.
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Another example of an agent protecting themselves from lawsuit is the practice of giving complete information. For example, the insurance agent who informs the policyholder of the minimum insurance coverage required by the state, but, given the client’s assets, suggests a larger amount of cov-erage as appropriate. The client then has the option of declining the addi-tional coverage, thereby, releasing the agent of a negligent act. The agent should then document that the coverage had been discussed and refused by the client. The agent may go as far as having the client sign a form ac-knowledging this denial of additional coverage. In this way, the client will not be able to claim that the agent failed to offer the adequate coverage needed.
Insurance agents and brokers can be held liable for a vast array of actions. It should be noted that they can be liable to both the client and to the insur-er for which they work. We should also make a distinction between agents and brokers. Agents are considered representatives of the insurer. Brokers are considered representatives of the insured. The broker’s primary alle-giance is to the client. Knowledge of the broker is not considered to be knowledge of the insurer. The agent and the insurer are deemed to have the same knowledge.
Express Authority & Ostensible Authority
Identifying the distinction of knowledge could be critical if an insured chose to sue both the agent or broker and the insurance company. Normally, if the broker is involved the insurance company can escape liability. As with anything, there are always exceptions. Sometimes when dealing with the agent, the insurer can still be held liable even if the agent oversteps their express authority. Express authority refers to the powers given to the agent in the agency agreement or contract. In addition, the agent also has certain implied powers. The courts have used the doctrine of ostensible
authority to give agents those powers the public reasonably expects them
to have. An example of liability would be that of a life insurance agent who accepted the premium for a life insurance contract with a company for which he was not contracted. The insurer had not given the insurance agent the authority to accept the premium. The insurer could be bound since it is rea-sonable for the public to believe that an agent has the authority to accept premiums.
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Another example where ostensible authority can be invoked is when an agent is told by the insurer that the company will not write homeowners coverage on homes over 50 years old. Assuming the agent writes a policy on a home over 50 years old, the insurer could still be liable to the insured if any claims arose since there would be no reason for the insured to know the issuance of such policies was forbidden. Of course, in these situations, the insurer may have recourse against the agent for the actions they took.
In many situations, the agent/broker distinction can become less critical. Instead, the actual facts of the situation will be looked at to determine whom the agent or broker was representing:
1. the insured, or 2. the insurer.
In any case, the agent or broker must and is expected to act with reasona-ble care and diligence when representing the insured or insurer. Another aspect to look at is how the courts view the insurance agent. Assuming the court views the insurance agent as a professional, the applicable standard of care would be that of the skill and expertise of the average professional in that industry. We all know, of course, that some agents are more expert than others. Those who overstep the bounds of common sense cause the entire industry to experience change, as states legislate to protect the con-sumers.
We can look at court cases that discuss the implied law duty of good faith and fair dealing that is imposed on agents and insurance companies. In the case of Fletcher v. Western National Life Insurance Company, the court stat-ed:
We think that, similarly, the implied-in-law duty of good faith and fair dealing imposes upon an insurer a duty not to threaten to withhold or actually withhold payments maliciously and with-out probable cause, for the purpose of injuring its insured by de-priving him of the benefits of the policy.
In a similar court case, United States Fidelity and Guaranty Company v.
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Where an insurer fails to deal fairly and in good faith with its sured by refusing without proper cause to compensate its in-sured for a loss covered by the policy such conduct may give rise to a cause in action in tort for breach of an implied covenant of good faith and fair dealing. The duty violated arises not from the terms of the insurance contract but is a duty imposed by laws, the violation of which is a tort.
The courts here are referring to insurers in speaking of the duty of good faith and fair dealing, but it is also applicable to the insurance agent. Typi-cally, if the insurance company is sued for bad faith, the agent will also be named as a defendant.
Torts & the Basis for Liability Claims
Question: What is the legal basis for a liability claim?
Answer: A claim that is based on a liability imposed by law which develops as the result of the invasion of the rights of others. This legal right is more than a moral obligation of one person to another. This legal right has the backing of the law. Legal rights impose many specific responsibilities and obligations. The invasion of such legal rights is deemed a legal wrong. The legal wrong may be:
1. criminal (public), or 2. civil (private).
A criminal wrong is an injury involving the public at large and is punisha-ble by the government. The action on the part of the government to effect a conviction and impose fines or imprisonment is termed a criminal action. A civil wrong is based upon two things:
1. torts, and 2. contracts.
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Torts & Contracts
Torts are wrongs independent of contract wrongs. In other words, they involve actions of the agent or others but not the contract. This includes false imprisonment, malicious prosecution, trespass, conversion, battery, as-saults, defamation (libel and/or slander), fraud, and negligence.
Contracts may involve legal wrongs when implied warranties are violated or contract obligations are breached.
Liability Under Torts
As stated before, torts include all civil wrongs not based on contracts. As a result, they are a broad residual classification of many private wrongs against another person or organization. Torts occur independently of con-tractual obligations and may result from:
• intentional acts or omissions,
• strict (or absolute) liability imposed by statute law, or • negligence. Most torts are based on negligence.
Insurance Agents’ Civil & Criminal Violations
Insurance agents can also be found liable for statutory violations, both criminal and civil. For insurance agents whose livelihood is dependent upon their employment, this is an especially serious form of liability since criminal violations can require a conviction and impose fines or imprisonment or both, depending on the severity of the crime. Sometimes the insurance agent is given the option of having a hearing before the state insurance commissioner rather than appearing in court. In other instances, if the agent surrenders their license voluntarily, no further action is taken.
Liability consequences of a crime are usually uninsurable. Liability consequences of a civil wrong are usually insurable.
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Fraud is perhaps the most common crime committed by insurance agents. The following are some examples in the “Professional Liability Pitfalls for Fi-nancial Planners” by Cheryl Toman-Cubbage of real-life cases of crimes committed by insurance agents.
In Colorado, a man was involved in a car accident that resulted in almost $7,500 damage to his car and another vehicle. When he contacted his insurance agent, he was assured that the dam-ages would be paid. But, as it turned out, the agent was not li-censed to sell insurance in Colorado and had never sent in pre-mium to the insurance company. As a result, the man found out he was uninsured. He had no recourse against the insurance company for the agent’s action since, in Colorado; it is unre-solved whether an insurance company is responsible for the ac-tions of its salespeople. He sued the agent and was awarded $5,000, but the agent filed bankruptcy, so the plaintiff was una-ble to collect the judgment. The agent did surrender his license. Another case involved an elderly couple who took the advice of an insurance agent to discard all their old policies and buy the health insurance he sold. They gave the agent a check, but never received a policy. After contacting the company the agent said he worked for, the couple found out he was no longer em-ployed by this company and had no authority to sell its policies. A result of this incident and other circumstances similar to this, the agent’s license was revoked and he was convicted of theft and sentenced to five years’ imprisonment.
We have probably all heard of stories of unscrupulous agents taking ad-vantage of their clients. States pass legislation in the hope of reducing fraud, but it is unlikely that laws will ever be entirely successful. What the examples above show is that an agent can receive criminal punishment for acts of fraud they commit. Unfortunately, for many agents who commit fraud, no physical punishment is ever experienced, although they do com-monly lose their license to sell insurance. Some agents, however, will simp-ly move to another state and hope that their past does not catch up with them.
It has been said that an ethical code of conduct cannot be mandated. An agent is either ethical or not, and laws merely point out those who are not. While this may be true, laws (and resulting punishment) do at least prevent those who lack any ethics from continuing in the profession. Unfortunately,
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consumers will remember the unethical far longer than the hardworking eth-ical agent and financial planner.
Insurance Agent’s Breach of Contract
Contracts may involve legal wrongs when implied warranties are violated or contract obligations are breached. An insurance agent would likely not be sued individually for breach of contract. The insurance companies and agen-cies themselves are more likely to be sued for such a lawsuit since they would be viewed as responsible for denial of a claim or violation of a condi-tion.
However unlikely it is that an agent or broker would be sued for breach of contract, it is possible. We can look at the language of the case of
Milwau-kee Bedding Company v. Graebner:
It is a general rule that, where an application for insurance is made to an agent who represents several companies, no con-tract of insurance is engendered between the insured, and any particular company until such company is designated by the agent. But, where the company is selected by the agent, and in some manner designated as the company in which the insurance is to be written, a binding contract results. In such case the agent becomes the agent of the insured for the purpose of se-lecting the company.
The agent of the above case was found not guilty, but the language de-scribes the traditional relationship between a broker and the insured. It could also be assumed from the opinion that an agent can be liable for a breach of contract to procure insurance. For instance, in the case of Marano
v. Sabbio, an insurance broker promised to procure burglary insurance for
the client, but failed to do so. Some of the client’s property was stolen un-der covered circumstances. The court held the broker liable for the value of the property stolen under a breach of contract theory.
It has been said that an ethical code of conduct cannot be mandated. An agent is either ethical or not, and laws
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It is also possible for the agent and the insurance company to be sued for failing to act promptly on an application for insurance. This is sometimes presented as a negligent cause of action, but it has also been presented as a breach of an implied agreement to act promptly or as breach of contract.
Breach of an Implied Agreement Theory
Under the theory of breach of an implied agreement to act promptly, it has been found that the course of conduct of the agent, including solicitation of the application and acceptance of the premium, constitutes an implied agreement that the insurance company will act upon the application without unreasonable delay.
Breach of Contract Theory
Under the theory of breach of contract it has been found that the applica-tion is the offer and silence on the part of the insurance company or silence coupled with retention of the premium forms a contract. This makes the in-surance company liable for any unreasonable delays in acting on the applica-tion.
Legally Binding Insurance Contract
It is important to understand exactly when an insurance contract becomes legally binding. As stated before, the application is considered an offer of in-surance. The acceptance occurs when either the agent binds coverage or the policy is issued. By law, an insurance contract does not actually have to be in writing. However, it is normally in written form. While there are many reasons for this, one main reason is to determine when the contract was formed so that one may know when a loss is covered. For example, client ABC applies for coverage with XYZ insurance company on his car. By ac-cepting the offer of the client, the agent creates a written contract. If client ABC is involved in a car accident before he receives a written contract, the loss is still covered by XYZ insurance company.
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Relevance
The relevance of determining when a contract comes into existence relates to when and if a breach of contract occurs. It is obviously stated that no breach of contract can occur unless a binding contract actually exists.
In the past, a life insurance agent could not bind the insurance company. However, in the case of Smith v. Westland Life Insurance Company, the court stated this opinion:
“... an ordinary person who pays a premium at the time he ap-plies for insurance is justified in assuming that payment will bring immediate protection, regardless of whether or not the in-surer ultimately decides to accept the risk.”
In the case of Young v. Metropolitan Life Insurance Company, the courts stated a similar opinion:
“... the very acceptance of an advance premium by the carrier tends naturally toward an understanding of immediate cover-age though it be temporary and terminable.... In short to the ordinary layman, payment of the insurance premium consti-tutes payment for insurance protection....”
A Contract of Adhesion
In the first case mentioned, payment of the premium had been made. The courts are leaning toward viewing the insurance contract as a contract of
adhesion and tend to be harder on the agents and insurance companies in
finding a contract early in the negotiations. A contract of adhesion basically means that the insured has no option to change or negotiate policy terms. The policy is presented to the insured on a take it or leave it basis. In view-ing courts cases and decisions, it can be understood that any ambiguities in the insurance contract will be construed against the insurance company.
By accepting the offer of the client, the agent creates a written contract. If the client is involved in a car accident before he receives a written contract, the loss is still covered by the insurance company where application was made.
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For Review:
• Many financial planners start out as insurance agents or brokers and con-tinue to sell insurance after they move into the financial planning field. For this reason, financial planners will have the same liability problems that they did in the insurance field as well as additional liabilities as fi-nancial planners.
• Even if the financial planner did not start out in the insurance field, they would be involved in providing clients with the risk management advice and even perhaps, would begin selling insurance products. This would thus mean that a financial planner would need to know their liabilities in this field they are expanding to.
• Financial planners can look to court cases involving insurance agents to gain a better idea of how their field will be likely treated in the courts. Like the insurance agent, the financial planner will be viewed as a fiduci-ary, holding themselves out to the public as having special skills and/or knowledge.
• Like the insurance agent, the financial planner can be held liable for neg-ligence, breach of contract and statutory violations.
Accountant’s Liabilities
Looking at how accountants open themselves up to different liabilities will accomplish two things:
1. Help determine the liabilities that need to be covered. 2. If an insurance agent is an accountant also, it will help them
deter-mine where they may need to provide adequate coverage for them-selves.
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Quite often, accountants expand their field and become financial planners. Accountants deal with the finances of clients and performing such tasks as analyzing financial statements and preparing tax returns. However, unlike insurance agents and stockbrokers, accountants do not sell products, unless they have obtained a license to do so. It is their services that they sell. An accountant’s services involve the use of judgment when deciding what to do with the numbers. It is not hard to understand, then, that an accountant that negligently makes an error in the figures can be found liable.
There have been two important developments in the area of accountant li-ability:
1. The courts increasingly have become willing to find accountants li-able to their clients for their negligent acts. Prior to the 1950s, the courts were much stricter in awarding damages to clients.
2. Accountants are now being held liable to third parties. These third parties represent non-clients and people with whom the accountant has not contracted. As a result of this liability, the exposure to lia-bility claims for an accountant has significantly increased.
When Are Accountants Not Liable to Third Parties?
An accountant’s full liability exposures can be understood by reviewing a few court cases that deal specifically with this issue. A court case in 1931,
Ultramares Corporation v. Touche, where the defendants were Certified
Pub-lic Accountants who audited a company and supplied the company with 32 serially numbered copies of a certified balance sheet. The defendants knew that these copies would be used by the company to obtain future loans. The balance sheet showed a net worth of more than $1 million when actually, the company was insolvent and later had to declare bankruptcy. As a result, the plaintiff, who was considered the third party and relied on the balance sheet of the company, sued the accountants for negligently and fraudulently performing the audit. The court decided that the accountants could not be held liable for negligence to a person or people who were not parties to the original contract.
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On the surface, the decision appears to be very straightforward. If a per-son is not a party to the original contract, they cannot claim damages for negligence. However, the court did go on to state:
Our holding does not emancipate accountants from the conse-quences of fraud. It does not relieve them if their audit has been so negligent as to justify a finding that they had no genu-ine belief in its adequacy; for this again is fraud.
The court went on to state that an accountant can be liable to a third party who had not entered into the contract if the involvement of the third party was foreseeable. For example, if a client asks an accountant to prepare fi-nancial statements for the client to show a specific party with whom they do business, the accountant then knows a third party is involved and this in-volvement could be considered foreseeable.
The Ultramares case states two distinct views. On the one hand it states that an accountant is not liable to third parties with whom they have not contracted. On the other hand, the accountant can be liable to a third party if it is foreseeable that a third party will be involved or if the accountant acts in a fraudulent or grossly negligent manner.
Since it is not always clear when a third party involvement is foreseeable, or when the accountant has acted in a fraudulent or grossly negligent man-ner, the Ultramares precedent could be followed by various courts, yet very different judgments could be reached.
The two most common trends resulting from the Ultramares case are as follows:
Accountants can be held liable to a third party lender since they prepare financial statements for their client knowing they are to be used by the lender. From this, one could assume that a duty of reasonable care is owed to all actually foreseeable third par-ties. Or, the accountant must actually know a third party will be using the documents. This is a narrower view of third party lia-bility, and has been the most common view held by the courts. Accountants can be liable to all reasonable foreseeable third par-ties who will rely on the accountant’s work. This is a broader view of third party liability. As the court stated, the accountant can be found liable when he or she “knows the recipient intends
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yone who might rely accountant’s work product to have a finan-cial interest. Courts are now becoming increasingly likely to fol-low this broader view of liability.
Accountant Negligence
The area of liability for professional negligence is more relevant than is lia-bility for breach of contract. This is particularly true since many of the du-ties required to meet an accountant’s professional standard of care are the same duties required for financial planners. The most basic duty of these is the fiduciary duty. Like the financial planner/client relationship, the ac-countant/client relationship is “one founded on trust or confidence reposed by one person in the integrity and fidelity of another.” The fiduciary must always place the interests of the client above their own. If a potential con-flict of interest arises, the client must always be informed and be given op-portunity to seek another accountant. This duty would include reporting to the client signs of such things as embezzlement, check-kiting (in commerce, this means any negotiable paper not representing a genuine transaction, so check-kiting might be thought of as “flying a check before funds are availa-ble”), and cover-ups of delinquent accounts. However, the accountant as fi-duciary is not required to be a policeman or a detective. He or she is a watchdog, so their duty is more like an auditor. As such, they are required to alert clients to suspicions, but if nothing seems suspicious then he or she is not required to track down each element involved.
Insurance agents are required to have continuing education in most states to keep their insurance license active. The accountant has a similar re-quirement in that they have a duty to keep current or abreast of recent de-velopments in accounting and auditing practices. To help provide guidelines to accountants, there are the Generally Accepted Accounting Principles (GAAP), the Generally Accepted Auditing Standards (GAAS) and the Stand-ards for Accounting and Review Services Number 1 (SSARS 1). These standards state the minimum professionally acceptable conduct for account-ants. This means that if the accountant does not follow these standards, it could be viewed as evidence of negligence. However, the fact that an ac-countant follows these standards does not necessarily prove that they are not negligent. In the case of Securities Exchange Commission v. Seaboard
Corporation, the court held that compliance with GAAP did not protect the
accountants from a liability claim. In a similar case in the US Supreme Court, Thor Power Tool Company v. C.I.R. the court state that GAAP did not necessarily reflect what was considered income for tax purposes. An ac-countant should be aware that they must at least follow the state of the
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fession. Although, what may be required over and above that is open to de-bate by the courts.
One of the areas most difficult areas for an accountant and agent alike is that of providing tax services. With all the various changes in the tax laws, it is an enormous responsibility to be aware of these changes and their im-pact on clients. It is not hard to understand that if an accountant is not careful in giving tax advice to a client, the client could be audited by the In-ternal Revenue Service (IRS) and have to pay additional taxes and penalties. If this is a result of the accountant’s negligence, the accountant can be held liable for the financial losses that the client incurred. Typically, the account-ant is not responsible for the actual taxes due, but only for interest or penal-ties levied.
All professionals must avoid overstepping their boundaries of authority. The accountants and financial planners must not practice law, for example (give legal advice). If this happens, civil and criminal penalties could be the result. Offering tax advice is the most likely area of stepping over the boundaries of expertise.
Accountant Breach of Contract
Breach of contract is perhaps the most straightforward of the three areas of potential liability. It is imperative for the accountant to be as clear and specific as possible in order in a contract of service. If this is done, the like-lihood of a lawsuit for breach of contract based on a misunderstanding or difference of interpretation is reduced. However, the accountant’s failure to perform a duty that is specifically named in the contract would also be more obvious thus making it easier to prove a breach of contract in court.
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Most of the breach of contract lawsuits has been brought against account-ants due to vague or ambiguous wording in their contract and situations in which failure to perform is not quite so obvious.
Accountants’ Civil & Criminal Violations
The final area of potential professional liability for an accountant is viola-tions of a statutory duty. This is very important to the accountant since it typically involves the imposition of criminal sanctions against the wrongdoer. The obvious areas of criminal liability for accountants would be embezzle-ment, check-kiting, fraud and similar crimes that could result from having access to a company’s books. To add to this, an accountant can also be found guilty of violating the securities laws if they give a client investment advice. We can see how this situation might arise quite easily if an account-ant receives a fee or commission from a dealer for recommending certain securities. The American Institute of Certified Public Accountants views this as a conflict of interest on the part of the accountant and will subject them to professional discipline. Additionally, under the Investment Advisors Act, if the accountant accepts the commission, they may be considered an “in-vestment advisor.” The Securities and Exchange Commission could further discipline the accountant if they failed to disclose the fact that they received a commission. This could be considered to be an omission of a material fact, thereby subjecting them to discipline for breach of fiduciary duty.
Investment Advisor’s Liabilities
The term “investment advisor” covers a broader range of activities than those performed by a stockbroker. It does not cover as broad a range of ac-tivities as those performed by a financial planner. It must considered, how-ever, that since most financial planners would be deemed investment advi-sors, the court’s treatment of investment advisors clearly points out the standard to which a financial planner is likely to be held.
Most of the breach of contract lawsuits has been brought against accountants due to vague or ambiguous wording in their contract and situations in which failure to perform is
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The case of Securities and Exchange Commission v. Suter in 1984 set a trend: The Securities and Exchange Commission (SEC) is very likely to bring a lawsuit against an investment advisor deemed to have violated a securities act. This adds then to the category of people whom an investment advisor, insurance agent, or financial planner can be liable to.
The case of Levine v. Futransky in 1986 was a very important case because it was brought by individuals, not the Securities Exchange Commission (SEC). This case held the advisor to a strict standard of care since it allowed damages to be awarded against the investment advisor even though overall there was no loss.
The plaintiffs in the case were trustees and beneficiaries of various trusts. Over a period of five years, the defendant was employed as their investment advisor to manage certain investment portfolios containing trust funds. The defendant was hired based on his representation that he could invest the funds in relatively conservative covered options. However, he invested in riskier, uncovered options which resulted in a substantial loss to the portfoli-os.
The defendant disputed that damages could be established by the plaintiffs since the aggregate earnings of the other profitable trust fund portfolios he managed for the plaintiff’s exceeded the aggregate loss of the others. He claimed there was no damage since the overall result was a net profit to the plaintiffs.
The court disagreed. It stated:
In the instant case, this Court holds that plaintiff’s suffered dam-ages even though the investment portfolios incurred a net gain. Plaintiffs may be entitled to recover the difference between the losses incurred on the sale of the speculative securities and the greater amount the plaintiffs would have received had they not been defrauded and the more conservative securities had been bought and sold.
We can see the importance of this case since it points out the rights of dividuals against investment advisors. If it can be established that the in-vestment advisor made a material misrepresentation that the clients relied on, which in the above case, was found to constitute fraud, the investment advisor can be liable for the difference between the amount lost (because of the investment vehicles and the amount that would have resulted had the
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As stated earlier, the cases involving investment advisors are particularly relevant since investment advisors are performing the same functions as fi-nancial planners, though the fifi-nancial planners duties may involve a wider range of activities. Like so many cases, similarities will exist for the financial planner and the agent.
Stockbroker’s Liability
Stockbrokers’ or security dealer’s professional liability problems are par-ticularly relevant to financial planners. Since financial planners wear many hats, including insurance agent, investment advisor and even security deal-er, it is very important to understand the liability problems faced by security dealers.
When a client goes to a financial planner, he or she typically goes for the purpose of receiving investment advice. This is viewed as the primary func-tion of a financial planner - to help the client handle their money and invest it wisely. This includes providing insurance coverage, solving tax problems, saving for retirement, and planning one’s estate. When a client purchases a cash value form of insurance, they are investing in an insurance policy. When a client invests money in a tax shelter, they are investing their hopes that at the same time, a tax problem is being resolved. The same is true for retirement and estate planning. In order to plan for these things, it is nec-essary to invest the money for those goals.
Many stockbrokers have moved into the financial planning field in the same way agents have, so their potential problems reflect those of insurance agents. Initially the majority of financial planners were either insurance agents or stockbrokers. Stockbrokers were already involved in the business of investment planning, so it easily expanded into financial planning for their clients. One of the primary functions of a financial planner is to invest the client’s money or to provide the client with an appropriate plan to invest their money. Therefore, even if a financial planner did not start out as an insurance agent/stockbroker, they would still be involved in recommending and/or selling such investments. Some areas of products may require spe-cific licenses and it goes without saying that agents must obtain these.
