THE MISADVENTURES OF ERNIE AND OLIVER: POLICIES AND INSUREDS
Policy formatting and more E&O basics
By Christopher W. Cook
With the holiday season slowly approaching, Ernie and Oliver are thankful. They are eagerly offering insurance quotes to all their friends and family, and some are even obtaining policies. There have been no emergency operational issues since their extravagant opening. To them it seems easy. One problem—they haven’t reached out to anyone outside their immediate network. But that shouldn’t be exceedingly onerous for Ernie and Oliver. They’re both engaging optimists. It’s just a matter of finding someone willing to buy insurance from two guys with no knowledge or experience; oh my!
How about we go over some more E&O basics to help avoid a potential catastrophe like the foreseeable future for Ernie and Oliver?
Standard vs. nonstandard
Let’s talk about policies. There are standard and nonstandard forms—no definitions needed here. The most widely recognized provider of standard forms is ISO—the Insurance Services Office. The American Association of Insurance Services also offers standardized forms but doesn’t have as many product offerings as ISO.
Several companies create their own nonstandard policy forms, and agents must understand the differences among the coverages.
Providing forms for workers compensation policies is the National Council on Compensation Insurance (NCCI). Its forms are drafted with the needs of the average insured in mind and can be used across all industries—with modifications by endorsements to meet specific needs. More on endorsements later.
There are several advantages to using standard forms:
- Enhanced ability to set rates using pooled loss data
- Increased ability to generalize coverages
- Decreased need to compare numerous insurers’ policies word for word to determine which coverages are appropriate for an insured
- Consistent policy terms help define the scope of coverage in court cases
- Simplified claims settlement process
Periodically, the language in standard forms is updated based on court interpretations of the coverage, changing underwriting philosophies, and loss exposures.
Nonstandard policies are used where no standard form or market exists, or for risks that need specialized coverage. Several companies create their own nonstandard policy forms, and agents must understand the differences between the coverages.
The elements of a typical policy format include:
Declarations. The declarations page contains information about the insured, including name and address, policy period, policy limits, deductibles, premium and any attached endorsements. It is crucial that this information be correct and if any changes occur that they be modified by endorsement. Verify the accuracy of declarations page information with your clients and update if needed. This shows that you are concerned about their having the appropriate coverage and that you value their business. It also reduces the likelihood of an E&O claim.
Insuring agreement. This section details what causes of loss the policy covers, subject to provisions such as exclusions, limitations and conditions.
Covered property. This section varies from form to form. It provides detailed descriptions of what property is covered and what isn’t. There are three main categories of covered property: building, personal property of the insured, and personal property of others. The policy may contain sub-limits for each category of covered property.
Covered perils. This section lists the perils—such as fire, wind, vandalism or accident—covered by the policy. Open perils or special perils coverage specifies the perils that are excluded from the policy, whereas named perils coverage identifies perils that are covered by the policy. Some policies use the term “all risks” when describing open or special perils, but this can cause confusion by implying that coverage is broader than what is actually available.
Exclusions. Perils, hazards, conditions or circumstances that are not covered by the policy are listed in the exclusions. Exclusions can apply to specific perils, certain types of property or types of losses. Exclusions serve these purposes:
- Reduce or eliminate overlapped coverages, allowing policies to “dovetail.” Exclusions prevent duplicate charges and reduce conflicts between insurers.
- Eliminate coverage not needed by the average insured. Some insureds may not be exposed to certain risks. The coverage may be restored to the policy later, if needed, on an endorsement or separate form.
- Reduce the incentive to create a loss. Moral hazard refers to an insured’s incentive to profit from the policy by doing something illegal; morale hazard reduces the insured’s incentive to protect against loss because the policy will pay.
- Remove coverage for an uninsurable risk. Most insurers are unwilling to write coverages like flood, nuclear or war.
Definitions. Words with special meanings need to be defined in the policy; otherwise in a court case they take their traditional definitions from the dictionary. Definitions can be used to clarify, restrict or grant coverage and can appear italicized, boldfaced or in quotation marks.
Conditions. These set forth the rights and responsibilities of both the insured and the insurer. They can address subrogation, the insured’s duties after a loss occurs and how losses are apportioned when multiple policies apply. Violating a condition can lead to denial of coverage.
Endorsements. These are used to tailor a policy to the needs of an individual insured. They can:
- Grant additional coverage
- Eliminate or restrict coverage
- Change or add definitions to alter coverage
- Change or add conditions to modify the insurer’s or insured’s rights
- Schedule covered persons, projects or property
Standard endorsements are available, and manuscript forms can be drafted if needed. Some endorsements are brief, while others are like separate policies, with exclusions and conditions.
Package policies and insureds
Sometimes one policy can include two or more coverages that would otherwise be written individually; this is known as a package policy. Two common commercial package policies are the Business owners Policy (BOP) and the Commercial Package Policy (CPP).
- BOP—The Businessowners Policy provides property and general liability coverages to small businesses. It has limited underwriting eligibility, including a maximum of 35,000 square feet for the facility and $6 million in gross annual sales.
- CPP—This policy covers property, boiler and machinery, inland marine, general liability, pollution liability and automobile. The CPP has advantages like fewer coverage gaps, lower premiums, savings from package discounts and the convenience of a single policy.
Going back to individual policies, who is the insured—who is covered? Insureds are classified in one of three groups: named, automatic and additional.
Named insureds are the individuals or entities to whom the policy is issued. These names should be accurate on both the application and the policy. Be careful when listing multiple named insureds; unrelated insureds will need special attention.
Named insureds have the most responsibilities under the policy. They are required to pay the premiums. They receive cancellation notices and have the right to cancel the policy.
Automatic insureds in personal lines policies like auto and homeowners are members of the household who are related to the named insured by blood, marriage or adoption. This includes full-time students under age 24 who live outside the household while attending school. Others under age 21 who are in the insured’s care are also considered automatic insureds.
Automatic insureds in a commercial lines policy include employees, volunteers, real estate managers, members and managers of an LLC, spouses of the sole proprietors and partners, and permissive users of company vehicles.
Additional insureds are those other than the named insured or automatic insureds who are listed in and protected by the policy. They could be non-related individuals who have permission to drive a vehicle covered by the policy, like a nanny or housekeeper.
In our next installment, we’ll look a little deeper into policy analysis and discuss some of the topics we touched on this time around, like definitions, conditions and endorsements. Until then …