Terra Extraneus

Errors and omissions insurance policies for registered representatives and broker-dealers have been offered at different times by different companies and usually, quickly withdrawn from the market. One of the companies that has stayed in the market longer than most has been AIG / National Union.

But, as demonstrated in a consolidated case, Ryan v National Union, United States District Court, District of Connecticut, AIG / National Union has a strange way of handling these cases.

First, the policy excluded coverage for discretionary accounts or the exercise of discretion. Second, the policy excluded outside activities that included “any entity other than the broker-dealer.” Third, the policy had a relatively short “tail,” in that it excluded coverage for acts pre-dating the policy effective dates and additional time coverage in the “tail” provision.

In other words, about the only thing covered, if the insurance company had its way, would be claims arising during the policy period resulting from acts during the policy period in brokerage accounts (not fee based advisory accounts in which discretion was exercised rightly or wrongly), which typically would include only the old fashioned stock broker, commission and sales of securities. In the Ryan case, the federal court held that the exclusions did not exclude all possible claims that might be implicated by the pleadings in the arbitration proceedings, and therefore there was a duty to defend all the claims in the arbitration proceedings.

It is sad that the AIG / National Union product has become so prevalent among the few who can afford or do buy insurance. A better product issued by a company that was more concerned about its insureds would probably lead to a broader market. A broader coverage market would lead to lower premiums because there would be more buyers among which to spread the risks.

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While the annals of Oklahoma insurance law may not be whipped into a froth, the Supreme Court ruled that “actual cash value” in the insurance code means the same as other insurance code terms such as “fair value” and “actual value.” Tyler v. Shelter Mutual Insurance Company, 2008 OK 9. The opinion was issued in response to a certified question from a federal court. It took ten judges to decide the issue.

In another case, a jury was asked to decide whether an insured of Oklahoma Farmers Union Mutual Insurance Company was entitled to indemnity payments for a substandard wood roof. Because both parties admitted the policy was unambiguous, there was no fact question to submit to the jury, so the jury verdict was superfluous as a matter of law. Based on the unambiguous policy, the Court reversed and rendered, finding coverage and ordering a hearing to set damages. The question under the policy was whether the replacement of the hail damaged wood roof shingles with plywood decking and composition shingles would be covered. Farmers attempted to cover only the repair of the composition shingles because the policy limited coverage to materials of like kind and quality, and the wood shingles were not the same as the composition shingles and plywood decking. Gutowski v Oklahoma Farmers Union Mutual Insurance Company, 2008 OK CIV APP 8.

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After the United States Supreme Court defanged the tort system in Campbell v State Farm Insurance Company by limiting punitive damages to ten times actual damages, insurance companies almost uniformly reverted to their business methods employed prior to the advent of theories of recovery involving bad faith breach of contract. The primary method of boosting insurance company financial performance has almost always been by increasing the cash reserves the companies invest, such that in the modern era, most insurance companies make more money from their investments than they do their sales of new policies.

One of the ways insurance companies increase their cash reserves, and thus the size of their investments and the resulting investment profits is to refuse to pay claims to policyholders. Insurance companies accomplish this by tightening their claims investigation procedures and excluding claims, in whole or in part, on ever more detailed guidelines for claims payment. This method has several permutations. One method is to never actually deny the claim, but rather to put up so many requirements to qualify for payment, usually manifested in ever more clever paper work technicalities, that the policyholder eventually in exhaustion gives up. Another method is to do post claim underwriting.

Post claim underwriting is manifested in “investigations” of the claim that start with the initial application, if the application is still within the time it can be contested, and sometimes even if it is not, and look for any flaw or mis-statement. The initial application is often as much authored by the commission seeking (and sometimes commission hungry) insurance sales person as it is by the prospective insured or policyholder. The application questions are usually detailed and often use technical medical or other terms.

Most insureds and policy purchasers assume that the insurance company obtained a release of medical records from them for some purpose and that erroneous medical history answers will be corrected by a review of the medical records supposedly obtained. While this might or might not be true, a few months or a few years later when the major claim is being “investigated,” many companies often revisit the original decision to accept the policy, called “underwriting,” and determine if there were any errors in the application that could be characterized as wrong or fraudulent.

Companies that engage in this sort of retrospective underwriting analysis assume the insured or policy purchaser lied and assume the selling agent just faithfully took down their answers to the questions, even though the insurers know fully that the agents often have to explain the questions and help decide what the answer should be.

In a binding arbitration in California, Bates v Health Net, Inc., BC321432, [hat tip to Lisa Girion, Los Angeles Times, otherwise, no one would have known and to TerraX’s editor, Terry Hull, or I would not have known] the arbitrator wrote a lengthy report of the testimony about post-claim underwriting that led to policy rescission (cancellation). Health Net wanted out of the policy as soon as Ms. Bates developed breast cancer and $125,000 in medical bills. The arbitrator awarded Ms. Bates $9 million, some substantial part of that in bad faith punitive damages. Thus, this Award was doubly rare, a large award in arbitration to a consumer, and, a report on the practice of post-claim underwriting, which is typically illegal or typically unfair, or both.

The Award is presently on the LA Times website, the link is in bold above, and is an excellent explanation of the post-claim underwriting methodology. The only thing missing is the one thing only a Grand Jury could probably get a handle on, and that is the cold blooded actuarial data the insurance company likely used to determine whether post-claim underwriting denials would be cost effective in preserving or increasing reserves and profits. You can bet that even though this Award laid it out in cookie cutter clarity, there will be no hearings by the enforcement division of any Insurance Commissioner in any state. That makes Campbell v State Farm all the more effective to protect insurance company financial statements.

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Allstate won the battle in a Kentucky civil case last week, but the war continues. In several suits across the country, plaintiffs accuse Allstate of bad faith in how it handles claims, pointing to the now-famous “McKinsey documents” as proof.

However, in the Bluegrass State last week, a jury unanimously denied a $1.4 billion claim against Allstate. The case has some good lessons for attorneys and plaintiffs, even in claims that little resemble the bad-faith insurance lawsuit.

According to the Lexington Herald Leader, a 60-year-old woman sought the whopping $1.4 billion claim from Allstate Insurance Co. after a 1997 automobile accident. The car the woman was in was rear-ended by a truck driven by an Allstate insured. The woman claims permanent neck and back injuries. Allstate paid her $25,000, taking more than two years to settle her claim.

In her subsequent suit against Allstate, the woman’s attorney, J. Dale Golden (Golden & Walters, Lexington, KY) relied heavily on the “McKinsey documents.” McKinsey & Co. is the consulting firm that helped Allstate overhaul its claims-handling process in the 1990s. The documents are 12,500 PowerPoint slides which McKinsey created for Allstate, but which fell into the hands of Santa Fe trial lawyer David Berardinelli a few years ago. In various lawsuits, Allstate is in defiance of a court order in Missouri to produce the documents and has been sanctioned in two others states.

Berardinelli and two other attorneys wrote the 2006 book, From Good Hands to Boxing Gloves: How Allstate Changed Casualty Insurance in America. The book describes how Allstate’s claims-handling process changed under McKinsey & Co.’s guidance. As the title implies, Berardinelli claims McKinsey’s recommendations not only led to big changes at Allstate, but have transformed claims practices across the insurance industry.

As Business Week reports:

The title of Berardinelli’s book is drawn from a McKinsey slide that suggests that Allstate should treat some of its claimants with “boxing gloves,” rather than with its trademark “good hands.” … [T]he documents present a portrait of business strategies that are at odds with the insurer’s carefully cultivated public image. Rather than simply rushing to the scene of an accident and doling out cash, Allstate deploys a variety of systems set in place by McKinsey to make sure it pays the minimum necessary — and it plays hardball with those who seek more.

The Kentucky woman’s claims against Allstate were bolstered by dramatic testimony from a former Allstate claims manager, Debbie Niemer. Testimony from Niemer and others claimed that Allstate:

● Has focused on reducing its payouts on “minor-impact, soft-tissue” injuries, called “MIST cases,” which constitute the majority of injury claims.

● Seeks quick low-dollar settlements. If the injured fails to cooperate, Allstate switches to the alternate strategy of dragging out the claim to drive up litigation costs and force the claimant into submission.

● Has withheld potentially damaging information from claims files.

“If they just wouldn’t have been so consumed by the numbers and allowed the human element,” Niemer said. “If they had allowed the adjusters to see the person, not just the number, it would have been different.”

LESSONS FROM THE JURORS
With a “smoking gun” like the McKinsey docs, plus damaging testimony from one of Allstate’s own, how did Allstate walk away with a unanimous verdict? Jury verdicts are one of the great mysteries of courtroom life, but juror comments provide some clues:

● Golden’s tactic to seek a billion-dollar-plus bonanza backfired. In his closing, Golden told jurors the only way to drive Allstate to repentance was to deliver a massive verdict that would create headlines. “If you award 10, 20 or 30 million dollars in this case, Allstate will be high-fiving all the way to the champagne store,” he said.

One juror said the dollar amount turned her off. “I thought the figure that [the plaintiff] was asking for was outrageous,” said juror Betty Sherwood. “…I thought that when I first went into the trial two weeks ago. … [I]t was so obnoxious of her to ask for so much money.”

● Allstate also earned points when it pointed out that the plaintiff continued to buy her auto insurance from Allstate! We’ve seen this in our practice more than once, for example, when an investor wants to file suit against a brokerage house alleging mismanaged funds, but the investor still has his investments placed with that same house. Juror Kelli Miller said: “If Allstate is such a bad company, why in the world would you keep renewing policies from the very company you are seeking a billion dollars from?”

Golden said he will appeal the verdict. He also said he is considering a class-action suit against Allstate, even though a judge last year denied Golden’s attempt to turn the present case into a class action.

(Hat tip to Jeremy Thurman of Nix & McIntyre for pointing us to the Kentucky case.)

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In 1998, our story begins, when the homeowners, the Duensings, felt their kitchen floor get warm. Upon investigation, they theorized they had a leak from their hot water tank plumbing. They promptly shut in their hot water tank and called a leak detection company and their homeowners insurance company agent.

The insurance company, State Farm, arrived on the scene first, and without benefit of the investigation of the leak detection company, concluded there was no homeowners insurance coverage for the plumbing leak or any damage to the kitchen floor that would result from repairing the leak because there was no water damage inside the home. The homeowners policy excluded coverage for plumbing leaks.

Of course, the leak did some damage to the house. It washed out part of the support of the slab, resulting in settling damage to the house. State Farm was again summoned to inspect the house and once again denied coverage in early 1999, this time under an exclusion that refused to cover “earth movement.” State Farm also denied coverage claiming that the “earth movement” could be caused by anything, including a plumbing leak, and the damage would still not be covered.

Of course, this would be funny if it did not involve damage to someone’s home and a breach of trust by the very people paid to preserve the value of the home from peril.

“Earth movement?” Water damage to a home from a sudden plumbing leak is not covered? What is State Farm thinking?

State Farm claimed the insurance policy was “clear.” The Oklahoma court in 2006 that ruled upon this disagreed and held that “earth movement” did not necessarily include wash out of slab fill from a plumbing leak, because it would more likely be read to include earth quakes, volcanoes, sink holes, and subsidence from erosion. These are the kinds of natural calamities that would impact entire neighborhoods and cities and would not be a risk that could be controlled by the insurance company or the homeowner. Such risks have to be dealt with by government. But, damage from a plumbing leak is exactly the kind of risk that both an insurance company and a homeowner can grapple with, and if the homeowner loses the battle, the insurance company is paid to step up and preserve the value of the home.

Four other hard lessons should be noted from this case.

First, it took the homeowners six years to resolve an Oklahoma homeowners insurance coverage claim against State Farm. That by itself should have triggered a regulatory response by the Oklahoma Insurance Commissioner.

Second, the Oklahoma Insurance Commissioner was nowhere to be seen in this case even though the homeowners tried to involve them. The Oklahoma Insurance Commissioner is no longer a viable guardian of the Oklahoma consumer. The agency should be abolished and its function returned to the attorney general’s office. We might not be protected but at least the taxpayers will receive some relief.

Third, engaging a lawyer and instructing the lawyer to practice advocacy by letter did not move State Farm. This is more fallout from Campbell v. State Farm, the United States Supreme Court case in which State Farm obtained limitations under the 8th Amendment, the limitation on cruel and unusual punishment, on the power of juries to award punitive damages. State Farm has no reason to fear the courts or juries, they have been defanged, so mere entreaties by lawyers cannot impact State Farm’s decisionmaking.

Fourth, the court held that State Farm’s position was reasonable, even if it was wrong and even if it was a breach of the insurance contract to refuse to pay the claim, and reversed the awards for bad faith and punitive damages entered by the jury in favor of the homeowners. State Farm’s refusal to pay and insist on its exclusions was reasonable because some courts in other states had agreed with insurance companies that “earth movement” would include a washout out caused by a surprise plumbing leak. The net effect was that the jury judgment against State Farm dropped from $500,000 plus interest to $24,160 plus interest. Thus, after paying their attorneys, the homeowners did not recover enough money to make them whole, and they did not recover enough money to pay their attorneys enough to justify the initial filing of the case six years earlier. In other words, the attorneys lost money handling the case. Indeed, the homeowners recovered about as much as they paid in premiums during the years they were State Farm insureds and the six years the claim was pending with State Farm. Thus, the homeowners lost money on the insurance claim, too.

You can read the well written case decision yourself at www.oscn.net, and find the case at 2006 OK CIV APP 15.

The court’s decision was correct under the law. However, the Oklahoma Insurance Commissioner should be prohibiting Oklahoma homeowners from suddenly finding out that “earth movement” does not mean “earth quake,” but means whatever the insurance company wants to invent. The Oklahoma legislature should impose the “reasonable expectations” doctrine in all consumer insurance (called “personal lines”) policies and extend it to all policy amendments that do not result in a noticeable reduction in premium. Only if the insured sees the premium drop can the insured have any idea of the magnitude of the change. A policy not covered by the “reasonable expectations” doctrine should be a lot cheaper than a policy governed by that doctrine of law.

By now, State Farm and the other insurers active in Oklahoma have also likely amended their policies to make sure “earth movement” now covers plumbing leak washouts. The law of Oklahoma will assume insureds have read their policies and understood. That law may be fair for large businesses that can afford attorneys and professional risk managers to evaluate policy language changes. The Oklahoma Insurance Commissioner, however, should have disallowed such an amendment and should be watching out for consumers. Don’t count on it. Also, the legal system has been defanged, so do not expect any help from that quarter.

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USA Today reports: “More restrictions on teen drivers result in less accidents.” Ya think?

As each of our three sons approached 16, I told them the only car they would own is one they bought with money they earned themselves. In the meantime, my wife and I shared our cars with them, within very limited boundaries. When they did finally manage to get cars of their own, they were kept busy enough working to keep them paid for, running and gassed up, that they didn’t have much time or money left to get into much trouble.

My primary goal in taking such a hard line was to celebrate their 21st birthdays with each of them. Thankfully, we realized that wish.

Here are the:

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Oklahoma motorists often wonder why they have to pay so much in automobile insurance premiums. Beyond the avarice of insurance carriers, one legitimate reason is that Oklahoma allows, indeed encourages uninsured motorists. Anyone who has been in a serious automobile accident, especially if the at-fault driver was uninsured, knows this trauma very well.

The following discussion is not news to the insurance industry. Because it also deprives them of income, it is astonishing that they, too, are not active in forcing change. The insurance industry lobby in Oklahoma is as powerful as it is in most states, but for some reason will not take on the used car dealers.

In Oklahoma, whenever a used car is purchased from a used car dealer, the used car dealer has the statutory authority, granted through their license to do business as a used car dealer, to “paper tag” the vehicle sold. The Oklahoma used car dealer can issue this paper tag without any insurance verification. An Oklahoma tag agent could not do so, but a used car dealer can do so. A new car dealer could not paper tag a new car without first verifying the existence of insurance, but a used car dealer can do so.

Oklahoma statutes (47 O.S. §7-602) specify that “at the time of registration” an insurance verification shall be required. Used car dealers do not, it seems, “register” vehicles. Oklahoma statutes (47 O.S. §1137.1(E)) require used car dealers to use a “fibrous” paper tag. They seem to get this right, because those paper tags seem to last forever. The law does not require the used car dealer to strip the used car of the old tag, which is why there are so many used cars running around with a plate that is actually expired as well as a yellowing, curling, hanging-by-a-piece-of-tape paper tag. Oklahoma statutes (47 O.S. §583(F)) require used car dealers to purchase $25,000 of liability insurance for each of their vehicles. But this duty and this coverage appear to cease when the used car is sold and “paper tagged” for the new owner. That means the used car can literally be tagged and go off the lot without any insurance.

Theoretically, it will only stay uninsured for 30 days, until the new owner purchases the tag for the used car, but that is a long 30 days. Also, if the used car owner does not have automobile insurance at the time of purchase, it is probably due to a reason that is not likely change within 30 days. Thus, many used cars remain uninsured.

The average citizen of Oklahoma can protect himself to an extent by purchasing uninsured/underinsured motorist coverage (also known as “UM” coverage). But every year I meet two or three people who did not purchase UM coverage. Some thought they were saving money. Some thought the coverage would not cover anything but medical bills because they confused it with another coverage called “Med-Pay” coverage. Some people confused it with comprehensive or collision, never realizing it would cover their own injuries and not just the injuries of the machinery. Insureds that forego the purchase of UM coverage are required to sign a form indicating they understand what they are doing and are doing it intentionally, and not by accident. Thus, it is difficult for the insurance purchaser who waives UM coverage to blame anyone for his error.

Nevertheless, UM coverage is not the sole solution, in part because it transfers the cost of insurance to the purchaser of insurance, when that cost should have been paid by the uninsured motorist. Used car dealers should be prohibited from paper tagging a car at sale unless they obtain an insurance verification from the purchaser. This breech in the levee of Oklahoma financial responsibility laws should not remain open.

If the Oklahoma insurance industry will not lobby for a change in the law, then the least the insurance industry can do is spend the money to educate the public about the need for uninsured motorist coverage. The insurance agent has trouble completely filling that role because the insurance agent has a perceived conflict of interest in attempting to educate consumers about the coverages they need to purchase.

Where is the elected Insurance Commissioner of the state of Oklahoma on all of this? The Insurance Commissioner should be lobbying for a change in the law, too. Never mind…he was impeached, convicted, sentenced to three years and fined $20,000 last month.

[Kim Holland, the new Oklahoma insurance commissioner, was appointed by the governor and has been in office for one month.]

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“The first thing we do, let’s kill all the lawyers.” Dick the Butcher, King Henry VI – Second Part, Act 3, Scene 2.

Of course, Dick the Butcher meant it literally, murdering all the lawyers, because he was installing a new king. He was not considering installation of a Jeffersonian democracy. However, dismantling the ability to successfully sue insurance companies and other corporate giants has been the political and legal goal of these financial behemoths for the last thirty years. The status of that effort can be briefly summarized.

To a great extent, the diminution of the threat of a lawsuit, and especially the threat of awards of damages sufficient to be noted on a public company’s financial statements, has been achieved. In most states, “tort reform” has resulted in statutes that limit discovery (the means by which parties search for evidence from others unwilling to disgorge the information), limit damages awards, and limit punitive damages. These are topics for another day, and most of the changes to date have not been the sort over which any one would necessarily disagree.

However, as a society, we should have enough experience with these laws to determine whether the small policyholder or small tort claim has been rendered extinct, or placed on the endangered species list. If so, we should also be experiencing a relative increase in insurance company capacity because of reduced claim costs, resulting in reduced premiums for all of us.

The biggest change of them all came from the opinion of the United States Supreme Court in 2003 in Campbell v. State Farm Insurance Company. In that decision, the Supreme Court refined the law embodied in the Eighth Amendment of the Constitution. The Eighth Amendment limits the punishment that can be meted out by prohibiting “cruel and unusual” punishment. The Supreme Court applied this rule in the Campbell case in which State Farm Insurance Company suffered an adverse jury award against it of $145,000,000 in punitive damages, over and above a compensatory damages jury award of over $2 million. The actual damages award was reduced by the trial court to $1,000,000. The Utah trial court also reduced the punitive damages award to $25,000,000.

The Utah Supreme Court reinstated the punitive damages award of $145,000,000 and State Farm appealed to the United States Supreme Court. The United States Supreme Court reversed and concluded that pursuant to the Eighth Amendment, State Farm Insurance Company could not be “punished” for more than ten times actual damages. This decision has prompted a revision in “exposure analysis.” Because jury authority to punish is now limited to ten times actual damages, era of the unlimited exposure is now over.

It is interesting to note that the Utah Supreme Court concluded that State Farm’s conduct was reprehensible. The Utah Supreme Court concluded that State Farm engaged in a nationwide effort to meet corporate fiscal goals by means of a company wide cap on claim payouts. This scheme was referred to as the Performance, Planning and Review program. Because State Farm’s program to reduce amounts paid on claims to boost company financial performance was secretive, the Utah Supreme Court determined that State Farm would get caught once in 50,000 cases. The Utah Supreme Court was so offended by State Farm’s conduct, it reinstated the $145,000,000 punitive damages award.

The funny thing at the time was that State Farm Insurance Company never made much mention of the findings of the Utah Supreme Court, and the $145,000,000 punitive damages award, in any of their reports to policyholders. Maybe State Farm forgot it was a mutual insurance company and should report little things like that. Indeed, according to the United States Supreme Court opinion, State Farm failed to report a similar judgment in Texas in favor policyholders, too.

The case in question, Campbell, however, did not just involve greedy claimants demanding to be paid the full and fair value of their claims. State Farm ignored the advice of its own staff investigators to settle a case brought against its own insured, the State Farm premium paying policy owner, took the case, and thus its insured it was sworn to protect, to trial, and lost a judgment against their own insured for more than three times his policy limits.

Afterwards, State Farm’s advice to this family, that State Farm had agreed to defend and insure, was to put For Sale signs on everything they owned as quickly as possible. State Farm also refused to post a bond and appeal, violating the terms of its standard auto policy which guaranteed a defense through the appellate process. State Farm made much of the fact that the insured originally wanted to fight the claims, but, under most policies, and this one was no exception, the insurance company controls the defense and is the one that is supposed to view the claim with clinical detachment, especially when an emotional insured cannot. State Farm, which had control of the defense, tried to put the blame for its decision to defend the claim on the policy owner, the insured. In all, the United States Supreme Court characterized State Farm’s handling of the claim as one that “merits no praise.” Indeed, the “trial court found that State Farm’s employees altered the company’s records…”

This should have been an easy case for State Farm to evaluate because State Farm’s insured driver was passing on a two lane highway and ran out of room before endangering oncoming traffic, resulting in serious injury and death to the greedy claimants. Serious injury and death have a tendency to make claimants believe they should be fully compensated by the wrongdoer, i.e., greedy, in technical insurance parlance. Also, the State Farm policy insuring the wrongdoer was only worth $50,000, and most detached observers would suspect the policy would not be adequate to compensate the family of the deceased or the seriously injured claimant driver. Thus, State Farm’s evaluation of the accident and the injuries, including death, had to have been suspect. But, State Farm did not get it, and the evil and greedy lawyers representing the dead and injured just could not take a joke.

The United States Supreme Court could not seem to sympathize with the Utah Supreme Court’s obvious chagrin at State Farm. The United States Supreme Court justices probably are not allowed to drive or receive mail from their insurers. The Utah Supreme Court justices probably have to drive themselves to work, insure their own cars, and receive mailings from insurers twice a year at renewal time complaining about greedy claimants, introducing new policy language reducing coverage because of greedy policyholders, and increasing premiums because of both, i.e., the same stuff the rest of us have to look at about twice a year.

Two years have passed. Have insurance companies, led by State Farm’s example, become bolder in denying claims and offering lower amounts to settle claims? Have they become bolder in implementing programs to reduce claim payouts in order to strengthen their own balance sheets? Can individual policyholders find affordable legal counsel to handle their typically modest insurance claims? Under some state tort reform laws, limits on recoveries might even reduce the value of the claim further under the right circumstances. In most recent years, the largest corporate law departments were maintained by insurance companies, and State Farm was no exception. [Most recent surveys are either on pay for view sites or unavailable to the public.] Will the combined effect of tort reform and Campbell make small insurance claims so uneconomic to purse that affordable counsel will be a thing of the past? In other words, have they succeeded in killing all the lawyers?

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