An Overview of Commercial Insurance for. GEM Insurance Agencies, L.P.

for

Prepared by Ted Dimitry

of

GEM Insurance Agencies, L.P.

OVERVIEW / AGENDA

•

Introduction

•

The Main Players in the commercial insurance

transaction

•

The Main Areas of Coverage for commercial

insurance buyers

Introduction

Commercial insurance transactions are complicated and often misunderstood processes that involve multiple parties. Because every company buying insurance is different, every transaction is different. As companies grow and change so do their risk profiles, making insurance purchasing vary from year to year. This document is designed to outline the basics of the insurance process for startup and early stage companies. While intended as a guide, it is not designed to replace the services of an insurance professional such as a licensed agent or retail broker. You should consult and utilize an insurance professional in order to procure and bind adequate commercial insurance coverage.

The Main Players

Commercial insurance involves multiple parties, each fulfilling a different role in the procurement of coverage, the issuance of policies and the resolution of claims. These parties include:

• The Insured: The Insured is the insurance buyer, the entity that is covered by the commercial insurance and which would be reimbursed in the event of a covered loss. Most Houston Technology Center (HTC) clients and tenants will fall within this category. In marine and energy policies, especially those insured with overseas Insurers, “the Insured” can sometimes be referred to as “the Assured.”

• The Insurance Agent or Broker: This is the professional intermediary or intermediaries procuring insurance on behalf of the Insured. Typically, insurance agents are remunerated through commissions, which range from 5% on Workers’ Compensation policies to as much as 15% on commercial property and liability policies.

In some cases and usually for companies with unusual risk profiles, an agent will have to approach a “wholesale” insurance broker to access specialized insurance markets willing to cover more unusual classes of business. Usually, the retail agent/broker and wholesale broker will divide the commission between them, but some programs require that an extra fee be charged.

Note that while the terms “Agent” and “Broker” are commonly used interchangeably, they do have different meanings under strict legal interpretations. For example, Texas does not define the term “Broker” whereas “Agent” is a licensed insurance intermediary. Please refer to the Houston Technology Center’s Service Provider Network for a list of insurance Agents or Brokers.

• The Insurer: This is the insurance company or other entity that is providing the insurance coverage to the Insured. There are many different kinds of insurance carriers, but the distinction most important to most HTC clients/tenants is admitted versus non-admitted insurance providers. In Texas, admitted carriers have filed with

the state and which has been approved (authorized) by the Texas Department of Insurance (TDI) to write business in Texas. An authorized carrier is protected by the State Guaranty Fund should an insolvency (bankruptcy) of the Insurer occur, for a maximum per claim limit of $300,000. Other states have similar authorization and guaranty procedures. Workers’ Compensation claims are not subject to a Guaranty Fund limit in Texas.

It is important to note that an Insurer can also be referred to as “a carrier” (as in an insurance carrier), “underwriters” (if more than one underwriter insures a portion of a specific policy) or a “company” (as in an insurance company).

A “non-admitted” (unauthorized) carrier is not protected at all by the Guaranty Fund in that state should the carrier become insolvent. Albeit rare, it is a major issue when a carrier is declared insolvent, whether or not the carrier is covered by the Guaranty Fund. That being said, many specialized areas of insurance can often only be covered by the non-admitted carriers. This can include oilfield/energy, marine, major industrial, medical, aviation and coverage for other high-risk endeavors. Non-admitted Insurers are also referred to as “surplus lines” carriers.

Non-admitted or surplus lines carriers include some of the world’s largest or more highly specialized and responsible insurers which simply do not want to post bonds in every state of the United States. Licensed Texas agents may only place insurance with surplus lines carriers which have been approved by the TDI to do business in Texas.

• The Insurance Adjuster: Adjusters step into the insurance transaction only in the event of a claim for an insured loss. Sometimes the Adjuster is an employee of the Insurer – usually for minor losses or Workers’ Compensation claims. Other times, an Independent Adjuster is assigned – usually for major losses that have caused significant property damage to both the Insured and third parties or serious bodily injury claims where lawsuits are threatened (or filed) and the opinion of an impartial third party is required. Hopefully, HTC clients/tenants will not have to interact very often with Adjusters.

Insurance

Broker

or Agent

Usually, an Insured (an insurance buyer) will contact an Insurance Broker or Agent, who will then interact with the Insurer to negotiate the terms of insurance (the “risk transfer”), as shown below. These negotiations include the terms of the insurance policies and the pricing considerations (premiums) the Insured is to pay in exchange for the transfer of risk (the insurance).

To secure the transfer of risk through an insurance policy, the Insured pays the Insurance Agent or Broker the “gross” premiums. These include the Agent’s commissions for the insurance policy in question. The Agent will then remit the “net” premiums to the Insurer.

Insurer

Insured

Independent

Adjuster

Transactional

Relationship

Transactional

Relationship

Little Direct Interaction

“Risk Transfer”

Negotiations:

Policy Terms & Price

Insurer

Insurance

Broker

or Agent

Gross

Premiums

Net

Premiums

Insurer

Insurance

Broker

or Agent

Insured

Some Insurers require direct payments and will therefore directly bill the Insured, paying the Agent’s commission at a later date.

As noted above, the Insurer will then issue an insurance policy in return for the paid (or the promise to pay) premiums. Insurance policies are “contracts of adhesion” and should be reviewed carefully by both the insurance buyer and the intermediary.

It should be noted that just as some Insurers will bill an Insured directly, some will also issue a policy directly to the Insured.

Policy Issued

To Insured:

Insurer

Insurance

Broker

or Agent

Insured

As noted above, an Insurance Adjuster generally will only come into the insurance transaction in the event of a loss for a claim that is filed under a relevant insurance policy. Usually, the Insured reports the claim to the Agent or Broker, who will in turn report the loss to the Insurer. The Insurer would then appoint either a company or an independent Adjuster to investigate and settle the claim. This process is outlined below, although greater detail will be presented in the section outlining the claim process.

Insurance

Broker

or Agent

The Main Areas of Coverage

For HTC clients and tenants, there are likely to be three main areas of coverage: • Liability Insurance

• Property Insurance

• Life Insurance, Health Insurance & Benefits

Liability Coverage is further segmented into different lines of insurance coverage that address various types of liabilities to third parties. For example, the liability a company employee has from driving a company car is very different than the liability an insurance buyer can incur from inadvertently violating a contract. The former is covered by a Business Auto Liability policy while the latter is addressed within most Commercial General Liability policies. Workers’ Compensation is a different type of coverage that is often coupled with Employer’s Liability.

Insurer

Claim Reported

Through Broker

Insured

Company or

Independent

Adjuster

While HTC clients and tenants are likely to focus on the first several lines of coverage outlined below, the following list shows the many different kinds of liability coverage that exist in the insurance marketplace.

• Commercial General Liability (CGL – can include premises liability, liability arising from ongoing operations, liability arising from completed operations, products liability, liability arising from personal and advertising injury to third parties, contractual liability, liabilities from inadvertent damages to third parties that are not covered elsewhere)

• Workers’ Compensation & Employer’s Liability (WC & EL – very regulated, includes statutory liability under the applicable state’s Workers’ Compensation code(s), statutory liability arising from federal laws like OSHA and the LHWCA, and liability arising from allegations of employer negligence)

• Business Automobile Liability (often regulated, can include liability arising from company-owned vehicles to third parties arising from operation of covered vehicles in the course of business, uninsured/underinsured motorists protection, personal injury protection, often coupled with Business Auto Collision & Comprehensive coverage in a Business Auto Policy)

• Professional Liability (a.k.a. Professional Indemnity or Errors & Omissions Insurance - engineers, architects, consultants, network operators, attorneys, etc.) • Employment Practices Liability (EPL - discrimination, sexual harassment, unfair

hiring/firing practices, hostile work environments, etc.)

• Directors’ & Officers’ Liability (D&O – covers liabilities incurred by directors and officers of a company)

• Fiduciary Liability (liabilities to shareholders, bondholders and other stakeholders) • Aviation Liability (owned or non-owned)

• Charterer’s Legal Liability (for chartering boats, ships or other vessels)

• Protection & Indemnity Coverage (for owned boats, ships or other commercial vessels)

• Kidnap, Ransom & Extortion (typically bought for employees and managers traveling to and working in less secure parts of the world, typical areas of the world include Mexico, South America, Nigeria, the Middle East, the former Soviet Union and Southeast Asia)

• Environmental or Pollution Liability (environmental cleanup liabilities due to pollution-related events or damages to the environment)

• Wharfinger’s / Stevedore’s Liability (liabilities associated with loading and unloading of vessels from a dock, includes the liability of providing a safe berth) • Maritime Employer’s Liability (liability arising from federal legislation pertaining

to a vessel’s crew or others claiming to be members of a crew or status as a seaman under the Jones Act, a.k.a. the Merchant Marine Act of 1920)

There may be other types of liability coverages available. Typically, primary liability policies have a $1 million limit per occurrence, per accident, per incident, etc. Commercial General Liability policies, however, often have a $1 million limit per occurrence with a $2 million annual aggregate limit. Under such policies, each loss is insured up to $1 million, but an Insured can have up to $2 million in insured losses any given policy term (usually 12 months).

Umbrella and Excess Liability: Due to this common $1 million limit on the types of policies outlined above, many commercial entities also purchase an Umbrella or an Excess Liability policy. Larger commercial entities may purchase several layers of coverage. However, not all liability coverages can “fit” under an Umbrella or an Excess Liability policy due to a given Insurer’s underwriting parameters.

For example, a severe accident in the work place (such as a bad burn or a paralyzing injury) might be covered under Workers’ Compensation as per the local statutes. An injured person might be rightfully entitled to years of Workers’ Compensation benefits, totaling in millions of dollars in covered claims. State laws and Workers’ Comp insurance providers take this into account and therefore Workers’ Compensation policies pay as prescribed in the local Workers’ Comp statutes.

Employer’s Liability, however, is often covered under the Umbrella, as it is negligence-based (the employer is accused by an injured employee or an injured/deceased employee’s family of negligence). Limits for Employer’s Liability vary by policy, but the maximum typically offered is $1 million. An Umbrella or an Excess Liability policy will pick up legitimate covered losses over the $1 million limit.

Professional Liability, Directors’ & Officers’ Liability, Employment Practices Liability, some Pollution/Environmental Liability and several other types of liability are often not scheduled under an Umbrella policy due to widespread underwriting practices. Thus, these specialty lines of coverage often offer higher limits for additional premium ($3 million, $5 million, $10 million, etc.).

It is important to note that there is a difference between a typical Umbrella policy and an Excess Liability policy. Most Umbrellas have a “drop-down feature,” meaning that if the underlying insurance is eroded or consumed by covered losses, then the Umbrella will “drop down” to serve as the Insured’s primary coverage until the policy term expires or the remaining limits are used up. However, an Excess Liability policy does not usually have this feature, attaching at the underlying limit stated in the policy (at $1 million or more). Some Umbrellas written by non-admitted carriers do not have drop-down features while some Excess Liability policies can be tailored to offer this kind of provision.

The chart below shows a typical Liability Insurance Portfolio for a commercial entity engaged in more or less “standard” business activities. Companies active in the energy, aviation, marine, aerospace, professional services or financial services industries will often buy other lines of insurance as well in order to cover exposures not addressed by the typical insurance program.

Automobile Liability Workers’ Compensation and Employer’s

E

E

x

x

c

c

e

e

s

s

s

s

L

L

i

i

a

a

b

b

i

i

l

l

i

i

t

t

i

i

e

e

s

s

U

U

m

m

b

b

r

r

e

e

l

l

l

l

a

a

L

L

i

i

a

a

b

b

i

i

l

l

i

i

t

t

y

y

Various Deductibles (if applicable)

Directors’ & Officers’ Liability (D&O), Employment Practices Liability (EPL), and Other Lines WC = Statutory Benefits Optional Limits for D&O, EPL, etc.

Property Coverage is often simpler and far more straightforward to understand. Insured property is covered at the values stated in the policy. Often, however, an insurance buyer must either schedule the property or account for it properly, as with variable inventory or similarly fluctuating values.

A buyer must be sure to accurately value insured property, rather than under-insuring an item to keep from paying more or over-insuring an item, thereby profiting from an insurance payment. Usually, such concerns are enforced by “Coinsurance Clauses,” which cause the insurance buyer to share in the loss if a covered item is lost or damaged in the event that the item is improperly valued.

Typically, there are two types of property – real and personal. Real property is immovable (buildings, real estate, fixed structures, etc.) while personal property is movable (tables, desks, chairs, computers, etc.). Other types of property such as large, industrial items are usually insured on separate or specialized policies (oil rigs, boilers, industrial inventory, etc.).

There are many different types of property coverage, but the list below outlines just a few that may be required by HTC clients and tenants.

• Office Contents (tables, desks, chairs, phones, wall fixtures, etc.) • Commercial Property (buildings or other permanent structures)

• Electronic Data Processing Equipment (computers, servers, monitors, etc. - often included in an Office Contents policy as outlined above)

• Cargo Coverage (can include items shipped by air, sea or land, can be bought for individual shipments or annually with specific reporting provisions)

• Inventory Coverage (often includes a maximum limit on location at any one time, can be dovetailed with the cargo coverage if the insurance buyer is responsible for delivering such items to its customers)

• Flood Insurance (not often covered by a standard Commercial Property policy, Flood insurance is usually purchased on a separate, stand-alone form that is backed by the federal government’s flood insurance program)

• Windstorm Coverage (may or may not be covered under the Commercial Property insurance form, buildings in “Tier One” counties close to the Gulf or southeast Atlantic Coasts often require separate windstorm insurance or excess windstorm coverage – it should be noted that some Insurers now regard the southeastern and eastern portions of Harris County as “Tier One” due to the major hurricanes in 2004 and 2005 – Ivan, Katrina & Rita)

• Earthquake Coverage (usually only a factor in California, but often requires separate insurance due to its exclusion under most Commercial Property forms); • Aviation (damage to owned aircraft)

• Marine Hull (damage to owned vessels)

• Boiler & Machinery (boilers and similar items can explode, which often requires a separate form of insurance)

• Oilfield Equipment (usually, oilfield equipment is covered under specialized policies designed to cover such things as downhole tools, drilling rigs, workover rigs, generators, etc.)

• Contractor’s Equipment (industrial equipment that is rented out to third parties can be covered under this form)

• Care, Custody & Control (non-owned equipment that is in an Insured’s care, custody and control can be insured, often as an addendum to one of the forms noted in this list)

Benefits Packages are often purchased by larger in a later stage of growth and development than most HTC clients. Some HTC tenants, however, may purchase benefits packages for their employees. These often consist of the following areas of coverage.

• Health Plans • Dental Plans

• Life Insurance Options • Investment/Annuity Options

• Accidental Death & Dismemberment Coverage

• Other Optional Coverages (Identity Theft for Employees, Travel & Accident Coverage, etc.)

• “Key Man” Insurance (life insurance on key managers, directors, employees or other personnel)

The Claims Process

As noted above, the Insured typically reports a claim to the Agent or Broker, who will in turn report the incident to the Insurer. The Insurer would then appoint either a company or an independent Adjuster to investigate and settle the claim.

Insurance

Broker

or Agent

After the claim is investigated by the Insurance Adjuster, a final report is submitted to the Insurer. Meanwhile, the Agent/Broker is in constant contact with the Insured, the Insurer and the Adjuster to monitor the status and resolution of the claim.

Insurer

Claim Reported

Through Broker

Insured

Company or

Independent

Adjuster

Claim Investigation through Adjuster

Insurance

Broker

or Agent

Insurer

Insured

Company or

Independent

Adjuster

It is important to note that an insurance underwriter may not necessarily be making the final claims decision. Most Insurers have large claims departments that monitor and ultimately decide upon the resolutions of claims based upon the circumstances of a loss and the provisions within an applicable policy. Some claims are cut-and-dried. Others, especially large liability claims, are more nebulous and can take months of investigation and examinations.

While the Agent or Broker will monitor a claim, it is also important to note that the Agent or Broker may not have much influence on whether or not a claim will be paid. Most professional Agents and Brokers focusing on commercial insurance will be their client’s advocate, but the ultimate decision on whether or not to pay a submitted claim (and to what extent) depends upon the Insurer.

Agents and Brokers do not often charge an additional fee for monitoring and servicing claims. In some cases, however, large industrial claims can result in an additional “claims processing” or “claims handling” fee to be charged against the insurance buyer. Such practices, however, are typically reserved for heavy industries like the offshore energy sector or large industrial risks. Most HTC clients and tenants are not likely to encounter this scenario.

Legitimate claims are paid directly to the Insured as outlined below.

Insurance

Broker

or Agent

Insurer

Insured

Company or

Independent

Adjuster

However, if a claim is denied or not paid in full, an Insured can file suit against an Insurer, depending on the merits of the Insured’s assertions that a claim should be covered. Since Insurers dictate the terms of most commercial insurance policies (contract of adhesion – “take it or leave it”), most such documents are interpreted in favor of the insurance buyer unless the circumstances around a loss are obviously excluded.

Insurance

Broker

or Agent

Insurer

Insured

Claim Payment Denied

Company or

Independent

Adjuster

Insured’s

Attorney

Insurer’s

Attorney

Expensive

Litigation

Suits against Insurers are often expensive, however, with no guarantee that the loss (or the cost of the lawsuit itself) will be recovered. They can also become messy, with the Insurance Agent(s) / Broker(s) and Insurance Adjuster(s) being called in to testify or perhaps pulled into the lawsuit. Although such situations are rare, regrettably, this can further sour the entire insurance process.

For smaller companies without the ability to secure qualified attorneys, a denied or insufficient claim can lead to insolvency or bankruptcy.

Insurance

Broker

or Agent

Insurer

Insured

Claim Payment Denied

Company or

Independent

Adjuster

Bankrupt!

Thus, it is important to closely monitor not only the quality of the insurance provider, but the terms and provisions outlined in each policy so as to avoid such an eventuality should a claim not be covered. Insurance is often the most significant expense for small and mid-sized companies and there is a tendency for buyers to seek to minimize insurance expenses as a balance sheet item. Unfortunately, this can result in inadequate limits, insufficient coverage, onerous and restrictive policy terms or financially unstable insurance providers.

An Insured should bear in mind that insurance is also a product, however, and should respond in the event of a covered loss. Insurance is often the only means a small or mid-sized company has to transfer or mitigate risks. Thus, it should be structured appropriately and proportionately to the applicable risks. In our litigious society, it is also often a requirement for conducting business in that most contracts (including lease agreements) have detailed insurance provisions. An insurance buyer should look to a professional insurance Agent or Broker for assistance in determining whether a policy is sufficient for the exposures at hand.