THE FINE ART OF CONTRACT ANALYSIS
Understanding policies is an important value-added service for clients
[E]very insurance contract needs
to be reviewed in its totality each and
every year. Surely, there are some parts that are
more important than others? No!
By Cheryl Koch,
CPCU, ARM, AAI, ACSR, AFIS, and Mary Belka, CPCU, ARM, ARe, RPLU, CIC
We recognize that reading insurance policies may not be every insurance professional’s favorite activity (authors of this article excepted), and perhaps some might even consider it a “necessary evil,” but few could argue that it isn’t one of the most important tasks performed in independent agencies. If you don’t understand the sometimes vast differences between various policies, you might be tempted to recommend the one with the lowest price.
After all, that’s what most insurance consumers think—that insurance is a commodity and all policies are created equal, so the only thing that really matters is the price. If we allow that kind of thinking to persist, we’ve lost not only the skirmishes and the battles, but we’ve lost the war as well.
Undoubtedly, one of the most important value-added services independent agents provide to their clientele is their ability to analyze the various policies available in the marketplace in order to make recommendations that are tailored to the needs of the insurance buyer. This means not only fully understanding the differences between the insurance proposals we receive from our carrier partners, but also those offered by our competitors. A tall order, perhaps, but one of the hallmarks of true insurance professionals.
Words matter in most aspects of life, but particularly when it comes to insurance. When working with clients, we prefer the phrase “insurance contract” to “insurance policy.” This may seem like splitting hairs but, once again, words matter.
Reminder: An insurance policy actually is a contract between the insurance company providing the coverage and the insured who purchases the protection. Our agencies are not parties to that contract. In fact, the only reason our name appears on the
declarations page is so the insurance company knows to whom to pay the commission!
We’re a facilitator, a middleperson, a matchmaker, and nothing more. That doesn’t mean we aren’t an essential participant in the process. In fact, we believe that the best insurance programs are those arranged by independent agents on behalf of their clients. But to do this properly requires a deep and thorough understanding of insurance contract language and the ability to translate that technical information into a language the buyer will understand.
How do we get to the point where we are qualified and comfortable explaining policy language to our clients? It all starts with R.T.S.P.—Read the Stinking Policy! How is it possible to make any reasonable recommendation to anyone if we don’t know what each of the insurance contracts we sell and compete against does and does not do?
Insurance is really a pretty simple business. At claim time, the only thing we have to guide us is the contract. It either provides coverage for the loss or it does not. We like to think that it’s the insurance company’s responsibility, but we all know that from time to time that the advocacy of an agent is the difference between a covered loss and one that is denied by the insurer. If we’re looking to add value, this is a sure-fire way to do it!
So, just what does it mean to analyze an insurance contract? Like so many other things, it’s a process.
We have to DECIDE. With all attribution to our colleague Casey Roberts, one can dissect an insurance contract by “deciding” how the contract operates:
Note that this is in no particular order (aside from spelling out the word); one must analyze the entire insurance contract to know what it does and does not do. An insurance contract is a complex legal document. It cannot be read and understood in a linear fashion. It’s not a novel where you can simply turn to the last page and see how it turns out!
Coverage is sometimes granted as an exception to an exclusion, rather than in an insuring agreement. Often, definitions contain wording that may expand or restrict coverage. Conditions might limit an insured’s ability to collect on a loss, despite the fact the contract may provide coverage. In other words, all of the contract provisions, working in concert, will define which losses are or are not covered.
So, of course, we have to read and understand each and every policy provision to know how it will (or will not) apply to our client’s loss. This is truly an art—but one we know each of you can master.
Let’s expand on the individual parts of a policy that were listed above:
Declarations. Some policies, particularly in the property lines of business, are “dec page driven,” meaning the entries on the declarations page really matter when it comes to coverage. For example, in ISO’s commercial Building and Personal Property Coverage Form (BPP) you will find the word “declarations” 37 times.
Coverage applies at the locations shown in the declarations or on the buildings and structures shown in the declarations or when an entry is indicated on the declarations page. If the entries on the declarations page are not completely accurate, coverage may not apply.
Exclusions. Insuring agreements, the grants of coverage, tend to be very broad. That’s because they can later be narrowed in the contract by exclusions. Exclusions are necessary for a variety of reasons:
- They address situations that are not commonly faced by the typical policyholder and, therefore, only add premium, but would not result in an increase in covered claims. An aircraft exclusion, for example, is included in many liability contracts because most policyholders do not have an aircraft loss exposure. If an insured actually has unusual exposures to loss, they are best handled by putting specific coverage contracts in place that are designed to address them for the appropriate premium.
- They are against public policy. We don’t insure punitive damages or intentional losses because it might encourage abhorrent behavior.
- If we cover everything, premiums would be unaffordable.
Conditions. These are the “ifs and whiles” of coverage. It may seem ridiculous, but we need to have a condition that states that it’s the insured’s responsibility to report claims. What’s the alternative? Should the insurance company be responsible to call each policyholder every day to see if they had a claim?
Another condition requires an insured to report crimes to the appropriate law enforcement agency. So if a theft occurs, that should be reported to the police. It’s a condition precedent to payment of a theft loss.
Insuring agreement. This is the broad grant of coverage in every insurance contract. It’s intentionally broad because the other terms and conditions of the contract more clearly define the coverage. If the insuring agreement says, as it does in the homeowners policy, that if the insured pays the premium the insurer agrees to pay their covered claims, that’s not really an overstatement.
Emphasis should be placed on the word “covered,” because those are the additional terms and conditions that will more clearly define coverage. We want insurance coverage to be broad, but not so broad that people who don’t have those exposures must subsidize those that do or so that insurance becomes unaffordable.
An insurance contract is a
complex legal document.
It cannot be read and understood in a linear
fashion. It’s not a novel where you can simply turn
to the last page and see how it turns out!
Definitions. Every modern insurance contract has its own glossary. This is important so that any words that might be ambiguous are clearly defined, because otherwise they will always be construed in the favor of policyholders—as they should be.
As we said earlier, definitions can sometimes function as coverage grants or exclusions. When reading definitions, it’s very important to pay attention if you encounter words like “except” or “unless” because that means coverage is either given or taken away by virtue of that definition.
Endorsements. Needless to say, the basic insurance contract is modified by the attachment of endorsements. In property insurance, endorsements are often an expansion of coverage. In liability contracts, they are often a contraction.
New endorsements get added at renewal and may escape the review of agents and brokers. It is critical to pay close attention to coverage that has been amended or removed, and to read through new editions of old endorsements to determine whether prior coverage has been reduced or eliminated.
The bottom line for agents and brokers is that every insurance contract needs to be reviewed in its totality each and every year. Surely, there are some parts that are more important than others? No! Every word in every contract matters, so it’s critical that the agency review each policy to determine if it’s in keeping with the insured’s expectations.
Sadly, the error ratio when issuing policies is very high—perhaps more than 50%. The last line of defense in making sure a policy is issued properly is the agency that ordered it. Policies need to be reviewed against applications in the management system, quotes received from carriers, and proposals provided to clients. We have to get it right because the stakes are high. We hope this remains an art form in our independent agencies, not a dying art.
Mary M. Belka is owner and CEO of Eisenhart Consulting Group, Inc., providing management and operations consulting to the insurance industry. She also is an endorsed agency E&O auditor for Swiss Re/Westport. A graduate of the University of Nebraska, Mary holds the CPCU, ARM, ARe, RPLU, CIC, and CPIW designations.
Cheryl Koch is the owner of Agency Management Resource Group, a California firm providing training, education and consulting to producers, account managers and owners of independent agencies. She has a BA in Economics from UCLA and an MBA from Sacramento State University. She has also earned several insurance professional designations: CPCU, CIC, ARM, AAI, AAI-M, API, AIS, AAM, AIM, ARP, AINS, ACSR, AFIS, MLIS.