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9.1 Agency Law: Application to Insurance
In this section we elaborate on the following:
- The law of agency relative to principals and agents and its role in insurance
- The implications of binding authority for agents, their principals, and the insured
- How the agency relationship is influenced by the concepts of waiver and estoppel
Insurance is sold primarily by agents. The underlying contract, therefore, is affected significantly by the legal authority of the agent, which in turn is determined by well-established general legal rules regarding agency.
The law of agencyLaw that deals basically with the legal consequences of people acting on behalf of other people or organizations., as stated in the standard work on the subject, “deals basically with the legal consequences of people acting on behalf of other people or organizations.”J. Dennis Hynes, Agency and Partnership: Cases, Materials and Problems, 2nd ed. (Charlottesville, VA: The Michie Company, 1983), 4. Agency involves three parties: the principal, the agent, and a third party. The principalIndividual who creates an agency relationship with a second party by authorizing him or her to make contracts with third parties (policyholders) on the principal’s behalf. (insurer) creates an agency relationship with a second party by authorizing him or her to make contracts with third parties (policyholders) on the principal’s behalf. The second party to this relationship is known as the agentIndividual who is authorized to make contracts with a third party., who is authorized to make contracts with a third party.It is important to note the difference between an agent who represents the insurer and a broker who represents the insured. However, because of state insurance laws, in many states brokers are not allowed to operate unless they also obtain an agency appointment with an insurer. For details, see Etti G. Baranoff, Dalit Baranoff, and Tom Sager, “Nonuniform Regulatory Treatment of Broker Distribution Systems: An Impact Analysis for Life Insurers,” Journal of Insurance Regulations19, no. 1 (2000): 94. The source of the agent’s authority is the principal. Such authority may be either expressed or implied. When an agent is appointed, the principal expressly indicates the extent of the agent’s authority. The agent also has, by implication, whatever authority is needed to fulfill the purposes of the agency. By entering into the relationship, the principal implies that the agent has the authority to fulfill the principal’s responsibilities, implying apparent authorityThe implied authority of the agent to fulfill the principal’s responsibilities.. From the public’s point of view, the agent’s authority is whatever it appears to be. If the principal treats a second party as if the person were an agent, then an agency is created. Agency law and the doctrines of waiver and estoppel have serious implications in the insurance business.
The law of agency is significant to insurance in large part because the only direct interaction most buyers of insurance have with the insurance company is through an agent or a broker, also called a producerAnother name for both agents and brokers. (see the National Association of Insurance Commissioners’ Web site at http://www.naic.org and licensing reforms as part of the Gramm-Leach-Bliley Act prerequisites discussed in Chapter 8 "Insurance Markets and Regulation").Steven Brostoff, “Agent Groups Clash On License Reform,” National Underwriter Online News Service, June 20, 2002. Laws regarding the authority and responsibility of an agent, therefore, affect the contractual relationship.
One of the most important agency characteristics is binding authority. In many situations, an agent is able to exercise binding authorityAuthority that secures (binds) coverage for an insured without any additional input from the insurer., which secures (binds) coverage for an insured without any additional input from the insurer. The agreement that exists before a contract is issued is called a binderThe agreement that exists before a contract is issued.. This arrangement, described in the offer and acceptance section presented later, is common in the property/casualty insurance areas. If you call a GEICO agent in the middle of the night to obtain insurance for your new automobile, you are covered as of the time of your conversation with the agent. In life and health insurance, an agent’s ability to secure coverage is generally more limited. Rather than issuing a general binder of coverage, some life insurance agents may be permitted to issue only a conditional binder. A conditional binderAgreement that implies that coverage exists only if the underwriter ultimately accepts (or would have accepted) the application for insurance. implies that coverage exists only if the underwriter ultimately accepts (or would have accepted) the application for insurance. Thus, if the applicant dies prior to the final policy issuance, payment is made if the applicant would have been acceptable to the insurer as an insured. The general binder, in contrast, provides coverage immediately, even if the applicant is later found to be an unacceptable policyholder and coverage is canceled at that point.
Waiver and Estoppel
The agent’s relationship between the insured and the insurer is greatly affected by doctrines of waiver and estoppel.
WaiverThe intentional relinquishment of a known right. is the intentional relinquishment of a known right. To waive a right, a person must know he or she has the right and must give it up intentionally. If an insurer considers a risk to be undesirable at the time the agent assumes it on behalf of the company, and the agent knows it, the principal (the insurer) will have waived the right to refuse coverage at a later date. This situation arises when an agent insures a risk that the company has specifically prohibited.
Suppose, for example, that the agent knew an applicant’s seventeen-year-old son was allowed to drive the covered automobile and also knew the company did not accept such risks. If the agent issues the policy, the company’s right to refuse coverage on this basis later in the policy period has been waived.
In some policies, the insurer attempts to limit an agent’s power to waive its provisions. A business property policy, for example, may provide that the terms of the policy shall not be waived, changed, or modified except by endorsement issued as part of the policy.
Unfortunately for the insurer, however, such stipulations may not prevent a waiver by its agent. For example, the business property policy provides that coverage on a building ceases after it has been vacant for over sixty days. Let’s suppose that the insured mentions to the agent that one of the buildings covered by the policy has been vacant sixty days, but also adds that the situation is only temporary. If the agent says, “Don’t worry, you’re covered,” the right of the insurer to deny coverage in the event of a loss while the building is vacant is waived. The policy may provide that it cannot be orally waived, but that generally will not affect the validity of the agent’s waiver. From the insured’s point of view, the agent is the company and the insurer is responsible for the agent’s actions.
This point came to a head in the mid-1990s when many life insurance companies were confronted by class-action lawsuits that accused their agents of selling life insurance as a private pensionWhen the investment portion or cash accumulation of a permanent life insurance policy is elevated to a position of a retirement account.Donald F. Cady, “‘Private Pension’ Term Should Be Retired,” National Underwriter, Life & Health/Financial Services Edition, March 1, 1999.—that is, when the investment portion or cash accumulation of a permanent life insurance policy is elevated to a position of a retirement account. There were also large numbers of complaints about misrepresentation of the interest rate accumulation in certain life insurance policies called universal life, which was discussed at length in Chapter 1 "The Nature of Risk: Losses and Opportunities".Allison Bell, “Met Settles Sales Practices Class Lawsuits,” National Underwriter, Life & Health/Financial Services Edition, August 23, 1999. The allegations were that insurers and their agents “furnished false and misleading illustrations to whole life insurance policyholders, failing to show that policies would need to be active over twenty years to achieve a ‘comparable interest rate’ on their premium dollars and used a ‘software on-line computer program’ and other misleading sales materials to do so.”Diane West, “Churning Suit Filed Against NW Mutual,” National Underwriter, Life & Health/Financial Services Edition, October 14, 1996. These were dubbed vanishing premiums policiesPolicies that policyholders were led to believe would be paid in full after a certain period of time, and they would no longer have to make premium payments. because the policyholders were led to believe that after a certain period of time, the policy would be paid in full, and they would no longer have to make premium payments.James Carroll, “Holding Down the Fort: Recent Court Rulings Have Shown Life Insurers That They Can Win So-called ‘Vanishing-Premium’ Cases,” Best’s Review, September 2001. Though no vanishing-premium case has been tried on the merits, litigation costs and settlement proceedings have cost companies hundreds of millions of dollars. Many large insurers such as Prudential, Met Life,Amy S. Friedman, “Met Life Under Investigation in Connecticut,” National Underwriter, Life & Health/Financial Services Edition, January 26, 1998. Money, Northwestern Life, Life of Virginia, and more were subject to large fines by many states’ insurance regulators and settled with their policyholders. Prudential’s settlement with 8 million policyholders will cost the company more than $3.5 billion.Lance A. Harke and Jeffrey A. Sudduth, “Declaration of Independents: Proper Structuring of Contracts with Independent Agents Can Reduce Insurers’ Potential Liability,” Best’s Review, February 2001.
Many of these companies created the new position of compliance officerIndividual charged with overseeing all sales materials and ensuring compliance with regulations and ethics., who is charged with overseeing all sales materials and ensuring compliance with regulations and ethics.Barbara Bowers, “Higher Profile: Compliance Officers Have Experienced Elevated Status Within Their Companies Since the Emergence of the Insurance Marketplace Standards Association,” Best’s Review, October 2001, http://www3.ambest.com/Frames/FrameServer.asp?AltSrc=23&Tab=1&Site=bestreview&refnum=13888 (accessed March 7, 2009); and “Insurance Exec Points to Need For Strong Ethical Standards,” National Underwriter Online News Service, May 19, 2005. Meanwhile, states focused on modifying and strengthening market conduct regulations. See the box Note 9.19 "Enforcing the Code—Ethics Officers" for a review of insurers’ efforts regarding ethics and for ethical discussion questions. Ultimately, the insurer may hold the agent liable for such actions, but with respect to the insured, the insurer cannot deny its responsibilities. “The vexing problem of vanishing premiums has proven to be an expensive lesson for insurance companies on the doctrine of respondeat superiorA Latin phrase referring to the doctrine that the master is responsible for the actions taken by his or her servant during the course of duty.—a Latin phrase referring to the doctrine that the master is responsible for the actions taken by his or her servant during the course of duty.”Lance A. Harke and Jeffrey A. Sudduth, “Declaration of Independents: Proper Structuring of Contracts with Independent Agents Can Reduce Insurers’ Potential Liability,” Best’s Review, February 2001. Neither insurers nor regulators consider an agency relationship as an independent contractor relationship.
EstoppelSituation that occurs when the insurer or its agent has led the insured into believing that coverage exists, and as a consequence, it means that the insurer cannot later claim that no coverage existed. occurs when the insurer or its agent has led the insured into believing that coverage exists and, as a consequence, the insurer cannot later claim that no coverage existed. For example, when an insured specifically requests a certain kind of coverage when applying for insurance and is not told it is not available, that coverage likely exists, even if the policy wording states otherwise, because the agent implied such coverage at the time of sale, and the insurer is estopped from denying it.
Agency by Estoppel
An agency relationship may be created by estoppel when the conduct of the principal implies that an agency exists. In such a case, the principal will be estopped from denying the existence of the agency (recall the binding authority of some agents). This situation may arise when the company suspends an agent, but the agent retains possession of blank policies. People who are not agents of a company do not have blank policies in their possession. By leaving them with the former agent, the company is acting as if he or she is a current agent. If the former agent issues those policies, the company is estopped from denying the existence of an agency relationship and will be bound by the policy.
If an agent who has been suspended sends business to the company that is accepted, the agency relationship will be ratified by such action and the company will be estopped from denying the contract’s existence. The company has the right to refuse such business when it is presented, but once the business is accepted, the company waives the right to deny coverage on the basis of denial of acceptance.
Enforcing the Code—Ethics Officers
In the minds of much of the public, insurance agents are up there with used-car dealers and politicians when it comes to ethical conduct. A May 2002 survey by Golin/Harris International, a public relations firm based in Chicago, ranked insurance second only to oil and gas companies as the least trustworthy industry in America. The factors that make an industry untrustworthy, Golin/Harris Marketing Director Ellen Ryan Mardiks told Insure.com, include perceptions that “these industries are distant or detached from their customers, are plagued by questionable ethics in their business practices, are difficult or confusing to deal with, or act primarily in self-interest.” Rob Anderson, Director for Change at Golin/Harris, provided the following list of corporate citizenship drivers:
- Ethical, honest, responsible, and accountable business practices/executives
- Company treats employees well and fairly
- Company’s products/services positively enhance people’s lives
- Company’s values/business practices are consistent with an individual’s own beliefs
- Company listens to and acts on customer and community input before making business decisions
- Company gets involved with and invests in the community other than in a crisis
- Company demonstrates a long-term commitment to a cause or issue
- Company’s support for a cause or issue has led to positive improvement and change
- Company donates a fair share of its profits, goods, or services to benefit others
- Company’s employees are active in the community
He notes that the two most critical things a company must do are to be seen as an “ethical and honest” company and as “treating employees well and fairly.”
How people might describe insurance companies is evidenced by the horror stories told on Web sites like screwedbyinsurance.com and badfaithinsurance.com. Of course, every industry has its detractors (and its detractors have Web sites), but insurance can be a particularly difficult sell. Think about it: in life, homeowner’s, property/casualty, and auto, the best-case scenario is the one in which you pay premiums for years and never get anything back.
Trust is important in a business of intangibles. The insurance industry’s image of trustworthiness took a big hit in the mid-1990s, when some of the biggest companies in the industry, including Prudential, Met Life, and New York Life, were charged with unethical sales practices. The class-action lawsuits were highly publicized, and consumer mistrust soared. The American Council of Life Insurers responded by creating the Insurance Marketplace Standards Association (IMSA)—not to placate the public, which remains mostly unaware of the program—but to set and enforce ethical standards and procedures for its members. IMSA’s ethics are based on six principles:
- To conduct business according to high standards of honesty and fairness and to render that service to its customers that, in the same circumstances, it would apply to or demand for itself
- To provide competent and customer-focused sales and service
- To engage in active and fair competition
- To provide advertising and sales materials that are clear as to purpose and honest and fair as to content
- To provide for fair and expeditious handling of customer complaints and disputes
- To maintain a system of supervision and review that is reasonably designed to achieve compliance with these principles of ethical market conduct
IMSA members don’t simply pledge allegiance to these words; they are audited by an independent assessor to make sure they are adhering to IMSA’s principles and code. The members, who also must monitor themselves continually, found it more efficient to have one person or one division of the company in charge of overseeing these standards. Thus was born the ethics officer, sometimes called the compliance officer.
Actually, ethics officers have been around for some time, but their visibility, as well as the scope of their duties, has expanded greatly in recent years. Today, insurance companies have an ethics officer on staff. In large companies, this person might hold the title of vice president and oversee a staff that formulates policy for ethics and codes of conduct and is charged with educating employees. The ethics officer may also be responsible for creating and implementing privacy policies in accordance with the Gramm-Leach-Bliley Act. Ethics officers’ mandate is to make sure that each employee in the company knows and follows the company’s ethical guidelines.
Sources: Vicki Lankarge, “Insurance Companies Are Not to Be Trusted, Say Consumers,” Insure.com, May 30, 2002; http://www.insure.com/gen/trust502.html; Insurance Marketplace Standards Association, http://www.imsaethics.org; Barbara Bowers, “Higher Profile: Compliance Officers Have Experienced Elevated Status within Their Companies Since the Emergence of the Insurance Marketplace Standards Association,” Best’s Review, October 2001; Lori Chordas, “Code of Ethics: More Insurers Are Hiring Ethics Officers to Set and Implement Corporate Mores,” Best’s Review, March 2001.
In this section you studied the following:
- Agents work on behalf of a principal (insurer) in establishing a contract with a third party (the insured)
- Principals fulfill their responsibilities by imparting binding authority to their agents to secure coverage with insureds
- Agents may provide coverage for risks that the insurer prohibits, waiving the principal’s right of refusal later
- Describe how agents can bring major liability suits from consumers against their insurers. Do you think insurers should really be liable for the actions of their agents?
- Explain the concepts of waiver and estoppel, and provide an example of each.
- Henrietta Hefner lives in northern Minnesota. She uses a wood-burning stove to heat her home. Although Ms. Hefner has taken several steps to ensure the safety of her stove, she does not tell her insurance agent about it because she knows that most wood-burning stoves represent uninsurable hazards. Explain to Ms. Hefner why she should tell her insurance agent about the stove.