Recent statutory enactments such as the Americans with Disabilities Act (ADA) and the Civil Rights Act of 1991, combined with case law developments, have significantly increased litigation and administrative filings charging discrimination, wrongful termination, sexual harassment, and similar employment practices-related allegations. As of January 31, 1994, the U.S. Equal Employment Opportunity Commission (EEOC) reports that 21,483 discrimination complaints have been filed since the July 26, 1992 enactment of the ADA. A number of recent employment liability cases have resulted in multi-million dollar settlements or judgments. Under the Clinton administration, the Family and Medical Leave Act has been signed into law, and legislation has been proposed in both Houses of Congress that would eliminate the caps on damages for violations of the Civil Rights Act.
These developments signify an increasing liability for employers in the employment practices arena. They also create an opportunity for risk managers to proactively address the major liability issues through the use of risk financing tools, including employment practices liability insurance products. Addressing these top management concerns will facilitate the operational and financial success of any organization operating in today's litigious society.
While many actions can be taken from a risk control standpoint to mitigate the employment practices liability exposure (e.g., modification of the job interview process to assure compliance with ADA requirements, development and enforcement of a sexual harassment policy, etc.), there is always the potential for a lawsuit against an employer. Although risk control mechanisms can afford some protection, the use of one or more risk financing methods is also recommended to address the explosive liability area.
Traditionally, risk financing alternatives have included: risk retention, non-insurance transfer and insurance. While risk retention may be appropriate for certain types of employment practices liability claims, such as an individual employee's allegations of wrongful termination, the increasing frequency of multi-million dollar claims makes this risk financing vehicle more and more unattractive. The use of non-insurance transfers through indemnity agreements or hold harmless agreements is limited in an employment setting because of the absence of potential third-party indemnifiers. Consequently, many risk managers are beginning to focus on insurance policies as a potential method to transfer the risk of employment practices liability losses.
There are several standard commercial insurance policies that are often reviewed to determine what, if any, protection is afforded for employment practices liability. These contracts include: comprehensive general liability (CGL) insurance; umbrella/excess liability insurance; directors' 6;r officers' (D&O) liability insurance; workers' compensation insurance; and fiduciary liability insurance. Although all the policies may provide (or at least give the appearance of providing) partial coverage for employment practices liability exposures, because each contract has policy limitations, none of the policies is wholly sufficient. The limiting terms and conditions of each contract are summarized in the following paragraphs.
The standard CGL policy responds to "occurrences" resulting in "bodily injury" or "property damage." "Occurrence" means "an accident, including continuous or repeated exposure to substantially the same general harmful condition." While "accident" is not defined in the policy, it generally is interpreted to include only unintended actions as reinforced with a specific exclusion for bodily injury "expected or intended from the standpoint of the insured." Thus, it is questionable whether an employment practices-type claim could qualify for coverage. In addition, the definition of "bodily injury" means "bodily injury, sickness or disease sustained by a person, including death resulting from any one of these at any time," thereby further restricting any potential recovery under a CGL contract.
While it may be possible to delete or modify some of the CGL exclusions, the following exclusions appear in the standard bureau form and could be enforced in order to exclude coverage under an employment practices liability claim: "bodily injury" or "property damage" expected or intended from the standpoint of the insured; assumption of liability under contract or agreement (except for tort liability and several other minor exceptions); and bodily injury to an employee of an insured "arising out of and in the course of employment."
Some potential coverage may exist under the personal injury coverage of the CGL contract. Personal injury coverage includes intentional torts such as libel and slander, which may be alleged in wrongful termination and similar cases. However, it is very likely that a number of other allegations, many of which may not be covered under the CGL policy, will be stated in the lawsuit. In addition, some CGL policies are now issued with a specific employment practices liability exclusion endorsement.
Umbrella and excess liability insurance oftentimes provide coverage on a "follow form" basis so that the policy responds in a similar fashion as the underlying CGL form. More recently, a larger number of these policies have been amended by endorsement to specifically exclude employment practices liability.
The standard for-profit corporate D&O contract covers only duly elected directors and appointed or elected officers. Other parties that may be named in the lawsuit, such as the corporate entity itself or employees (primarily managers or supervisors) are not insureds under the policy. However, non-profit D&O forms often extend to these parties. Employment practices litigation may include remedies involving non-monetary damages or equitable relief (for example, job reinstatement). Many standard D&O policies cover only monetary damages.
Several standard D&O policy exclusions could be invoked by the insurer to limit or defeat coverage. For example, willful violation of law exclusions may prevent recovery under the contract. The bodily injury, and in some cases personal injury, exclusions could be other means to exclude claims. It is also possible that a broadly worded regulatory exclusion could be used to deny coverage for employment practices liability claims filed with the EEOC or a similar state regulatory authority. Since employment practices liability insurance policies are now generally available in the marketplace, it is possible that a D&O liability insurer could preclude claims due to a failure to maintain insurance exclusion.
Although it would be rare for a D&O insurer to endorse the contract with an employment practices liability exclusion, there are some contracts that exclude employment-related claims. Some policies contain exclusionary language for sexual harassment and/or discrimination based upon the theory that coverage may be contrary to public policy or that the CGL policy provides coverage.
Firms may attempt to seek coverage under the "employers liability" section of a standard workers' compensation insurance policy. Because in many states workers' compensation is the exclusive remedy, it may be difficult for an insured even to tap the employers liability section of the policy. In addition, the employers liability section applies to "bodily injury by accident or bodily injury by disease." Bodily injury is not typically a charge under the employment practices litigation. The standard workers' compensation policy also sets forth several specific exclusions that may preclude or limit coverage. For example, the policy specifically excludes "damages arising out of, coercion of, or discrimination against any employee in violation of law."
Fiduciary liability insurance is intended to cover fiduciaries and others for claims resulting from acts, errors or omissions occurring in the carrying out of discretionary or administrative responsibilities associated with employee welfare and pension plan administration. If an employment-related claim is brought without allegations of errors or omissions in pension plan administration, the typical fiduciary liability policy would not respond. Coverage may be denied if it is determined that a fiduciary was acting in some other capacity when the incident took place. For example, it could be argued that a human resources manager was acting in a managerial capacity and not as a fiduciary, thereby bringing the claim outside of the realm of fiduciary liability. Lastly, some fiduciary liability insurance contracts specifically exclude discrimination.
Thus, there is limited coverage available under the major standard casualty insurance contracts. In response to the lack of coverage and the increasing interest in commercial insurance to cover the exposure, major specialty lines insurers introduced employment practices liability insurance (EPLI) products.
Lloyd's of London has offered for some time EPLI coverage under a defense-cost-only policy. This "first generation" policy provides coverage for the three specifically identified perils of wrongful termination, discrimination and sexual harassment. Indemnity payments, such as damages awarded as settlements and judgments, are not covered. Furthermore, the policy has several significant exclusions, one of which eliminates coverage for any class action suit.
"Second generation" EPLI contracts began to emerge in early 1992 in response to this liability exposure, which was expanding at an alarming rate. The impetus for the tremendous growth in the liability exposure was the new laws mentioned earlier, as well as greater public awareness of liability issues resulting from events such as the Anita Hill-Clarence Thomas hearings.
These newer policies, sometimes referred to as "human resources department errors' and omissions' insurance," are generally broader than the early Lloyd's product. Under most contracts, coverage is provided for both defense costs and indemnity payments. Some of these policies extend to named perils beyond the three traditional perils of wrongful termination, sexual harassment and discrimination.
Because of the rapid evolution of the products, current policies vary considerably with respect to several major policy provisions. It is important that risk managers carefully evaluate several key coverage issues related to the new policies including: extent to which both defense costs and indemnity coverage are provided; scope of the basic coverage whether the protection can be considered "laser" coverage or "broad form" coverage; offering of entity coverage; and exclusionary language found within the policy.
Some EPLI policies cover only specific exposures in a limited manner (i.e., "laser" coverage). Probably the most prominent of these was a policy that protected the organization only for claims arising out of the ADA. (Unfortunately, there was little demand for the product and it was pulled from the marketplace within the first year of its introduction.) Other forms provide very broad coverage by including a litany of covered perils.
The extension of coverage to the entity itself (and not just to directors, officers and employees) is a critical element in evaluating EPLI contracts. Most employment-related litigation names the organization as a defendant. If entity coverage is not provided under the policy, the insurer will not respond to the claim, or will respond only proportionately if covered individuals are also named in the suit.
As with any insurance policy, the exclusionary language, whether found in the exclusions section of the policy or elsewhere, is significant in defining the scope of coverage. Although the insuring agreement and definitions introduce restrictive covenants, the exclusionary language becomes paramount in determining the full breadth of coverage.
While keeping in mind key coverage issues, it is important to establish an organized approach to evaluating the EPLI policy. Many insurance contract review methodologies exist; however, risk managers should always ask: What is and is not covered? Who is covered? For what period is coverage provided, and how is coverage triggered? and, How much does this coverage cost and what limits are available? The use of a standardized contract analysis framework will facilitate a comprehensive understanding of the salient features of the policy.
WHAT IS COVERED?
The scope of coverage ranges from "laser" coverage (where only limited protection is afforded), to a specified perils format (including wrongful termination, sexual harassment and/or discrimination coverage) to a "broad" form policy with numerous perils covered. One such broad form policy available today includes coverage for the following exposures: wrongful dismissal, discharge or termination of employment; breach of any oral or written employment contract or quasi-contract; employment-related misrepresentation; violation of employment discrimination law (including workplace harassment); and wrongful failure to employ or promote. Other exposures covered in this broad form include wrongful discipline, wrongful deprivation of career opportunity, failure to grant tenure, negligent evaluation, invasion of privacy, employment-related defamation and employment-related wrongful infliction of emotional distress.
When evaluating the basic insuring provisions of policies, risk managers should carefully review the insuring agreement as well as the definitions. The insuring agreements of several major policies refer to coverage extending to "insured events" or "claims." A review of the policy definitions of these terms is critical to understanding the specific protection afforded under the policy.
WHAT IS NOT COVERED?
Probably just as important as what is covered is what is not covered under the policy. While exclusionary or restricting terms and conditions can be found throughout the entire policy, the exclusions section sets forth the majority of the limitations to the coverage.
As with most insurance contracts, there are a number of major reasons for exclusions. For example, the exposure may already be covered under another policy, or the peril may represent a potential catastrophic exposure the amount of which cannot be accurately predicted for rate development purposes. Other reasons an exclusion may appear in an insurance contract are that it would be against public policy to permit insurance protection for the wrongdoer, or the exposure, while commercially insurable, is unique and requires an additional premium charge or courts have granted coverage that was not intended by the insurer. Most of the exclusions commonly found in EPLI policies can be associated with one of the above reasons for exclusions. However, because the contracts are so new, there are not yet exclusions resulting from adverse court decisions construing broader coverage than intended.
Each EPLI policy is drafted differently, and thus each exclusion must be closely examined. Some of the more common exclusions that appear in the policies are for claims arising out of bodily injury/property damage (coverage may be found under the CGL policy), Employee Retirement Income Security Act liability (fiduciary liability policy may respond), contractual liability, workers' compensation, employee benefits, and pending and prior litigation. Claims arising from an incident of which notice was given to a previous insurer, pollution liability, willful violation of statute, or punitive or exemplary damages are also commonly excluded.
Several examples of varying policy exclusion wordings may be helpful in illustrating the nuances in the coverage forms. An exclusion for claims related to workers' compensation obligations is common among EPLI policies; however, it is important to note that under at least one of the contracts an exception is contained in the exclusion to reinstate coverage related to retaliatory treatment of a claimant. Another example of differing language relates to the treatment of mental anguish or emotional distress under the policy. One major insurer excludes loss, except for defense costs, for claims based upon mental anguish or emotional distress. Another major carrier has no specific exclusionary language whatsoever for this exposure.
In reviewing the exclusions for the willful violation of statute, the intentional causing of harm, or similar circumstances, it is important to determine if the exclusion applies only if the violation is adjudicated as intentional or purposeful. Often these cases are settled prior to adjudication, which may negate the exclusion. Similarly, if the contract has a severability provision (a clause that states that the acts of one insured are not imputed to other insureds), innocent parties will not be denied coverage merely because of the wrongful acts of another insured.
WHO IS COVERED?
A risk manager's evaluation of an EPLI policy should also include an analysis of who is covered under the policy. Coverage may extend to past, present or future directors, officers, managers and employees, as well as to the entity itself. In other cases, however, the insured parties may be more limited. For example, one major insurer is offering EPLI coverage as an extension to a D&O policy. The endorsement extends coverage beyond directors and officers to supervisory and other employees, but it fails to provide entity coverage. On the other hand, at least one stand-alone EPLI policy does not include coverage for directors and officers within the basic contract because it is expected that the insured organization's D&O policy would respond.
There are myriad other coverage issues related to EPLI products, many of which pertain to the claims-made nature of the coverage and how the coverage is triggered. Virtually all EPLI policies are written on a claims-made basis, meaning that coverage is triggered by a claim's being made (and in some cases also reported to the insurer) during the policy period. Some policies also contain retroactive dates that disallow coverage for wrongful acts occurring prior to the date. The claims-made coverage trigger is generally considered more restrictive than the comparable provision under an occurrence policy in which the protection is activated by an occurrence taking place during the policy period.
As with most claims-made policies, there may be several common limitations related to the claims-made nature of the EPLI contract, such as pending and prior litigation, prior acts and prior notice exclusions. Furthermore, a warranty statement regarding no known incidents that may give rise to claims under the policy may be required. The definition of "claim" must be carefully examined by the risk manager to ascertain whether both arbitration and administrative proceedings, such as EEOC hearings, trigger the coverage as well as judicial proceedings. One major policy extends coverage under the policy for civil proceedings commenced by the service of a complaint or similar proceeding, and arbitration, formal administrative or regulatory proceedings. Another major carrier's policy triggers coverage upon receipt of a written demand or notice in which damages likely to be covered by the policy are alleged, except labor or grievance arbitration subject to a collective bargaining agreement.
In addition to examining the event that can trigger coverage, it is critical to know how the claim should be reported, including the degree of detail necessary. The ability to report incidents that do not technically fall within the definition of "claim" under the policy is also an important aspect of coverage.
While coverage is often considered the most important element of an insurance policy, availability of adequate limits, reasonable deductibles and competitive pricing are also critical factors for consideration by the risk manager. Currently, there are relatively few markets offering standalone EPLI policies. A number of additional insurers offer the coverage as an extension to their D&O policy.
Available limits of liability range from less than $1 million to $10 million. Coverage is written with an annual aggregate limit of liability with defense costs coverage within the limit of liability and not in addition to the limit. Employment practices liability insurers are offering varying deductible options with the amounts determined by the size of the insured organization and the insured's risk adversity level. The deductibles can range from less than $10,000 for smaller accounts to $500,000 and higher for larger insureds. In addition to a deductible, a coinsurance or participation provision of up to 25 percent may apply where the insured is responsible to pay a small portion of the loss above the deductible. Most insurers are willing to offer an option with no coinsurance requirement.
Gaining an insight into the rating and underwriting of EPLI will assist the risk manager in presenting the account to the underwriter in the most favorable light. Although most underwriters offer quotations based upon the data included in, and attached to, the application, one major insurer interviews prospective insureds, primarily concentrating on human resources policies and procedures.
The underwriting process entails a comprehensive assessment of employment-related practices throughout the employment life cycle, from pre-hiring activities through termination. The stature of the human resources function within the organization is a critical factor, along with the utilization of outside legal counsel, outplacement firms and other professional service organizations.
From a rating standpoint, important factors include the number of employees, location of facilities (some jurisdictions are known to have more litigation of employment matters) and overall size of the organization. Past claims activity is a significant aspect of the rating and underwriting of an account.
The use of proper interviewing techniques, an employment application form that is in compliance with federal and state statutes and regulations, and lawful pre-employment testing procedures are all important underwriting factors. In addition, the underwriter considers the implementation of discrimination and sexual harassment policies and procedures as favorable risk characteristics. The reinforcement of the employment-at-will doctrine in employee handbooks, offer letters and other documentation is essential from an underwriter's perspective.
The underwriter also reviews job descriptions, performance evaluation methods and progressive discipline techniques. Termination procedures encompassing the use of outside legal counsel, outplacement services, equitable severance packages and proper authority level for the termination decision are also weighed. Expected mass layoffs or plant closings raise a red flag in the underwriting of an account.
Many of the items examined by the underwriter are also closely related to the adequacy of the risk control function within an organization with respect to its employment practices liability exposure. The risk manager should work closely with the human resources manager and with legal counsel to prepare a comprehensive submission for the underwriters. Details regarding proactive policy and procedures that are sensitive to employee relations, the use of outside specialists for outplacement and legal issues, and other favorable documentation should be highlighted for the insurers.
THE ROAD AHEAD
In order to address the emerging employment practices liability exposure, risk managers will need to evaluate risk financing techniques as a supplement to risk control activities. With the recent development of EPLI products, the diligent evaluation of these policies becomes critical to enhance the organization's ability to meet risk management, and more importantly, corporate financial objectives.
Just as the employment practices liability exposure arena is constantly changing, so is the insurance marketplace covering the exposure. Some additional insurance markets will probably enter the picture, while some may drop out. It is expected that the coverage will continue to be offered as both standalone policies and as endorsements to D&O policies.
Due to pressures of a competitive marketplace, some more restrictive policy features may be deleted or favorably amended. On the other hand, many of the insurers may be reluctant to modify the policies as they have spent considerable time and effort to develop the "state-of-the-art" policies. As these products mature, it is foreseeable that court cases may play a role in shaping the coverage.
Insurers may also increase their capacity as they become more familiar with the exposure they are assuming. Expected premium for any given account will be difficult to predict because of the newness of the product and the somewhat competitive marketplace. While initial pricing may be higher as some underwriters take a conservative approach, two forces are working in favor of insureds.
First, increased competition may drive down prices. And second, the insurers will want to sell the new products to meet production goals. It is expected that the EPLI marketplace will continue to experience rapid change in response to forces from both inside and outside of the insurance industry.
James J. Povlich is vice president and manager of the Financial Services Department at March & McLennan Inc. in Milwaukee, WI.…