Beware of Broker Contracts

One broker’s standard client services agreement a few years back provided that the broker would offer advice and procure policies — but that the client must review the policies and the broker’s work for any mistakes.

Sound reasonable? It shouldn’t, according to one insurance law attorney.

In fact, not only could such language leave organizations vulnerable to risks when policies aren’t in accordance with a risk manager’s expectations, but the brokerage may argue in court that the exposures were the fault of the insured, said Finley Harckham, senior shareholder with Anderson Kill PC, a New York-based firm that represents large policyholders in disputes with insurance companies.

“Similar types of requirements exist in current contracts between large brokerage firms and some of their customers,” he said.

The broker argued it wasn’t responsible for not securing the desired policy because the insured should have been aware of the problem earlier and pointed it out.

Harckham said he handled a case for a client a few years ago where a large brokerage relied on such a clause to contest liability in a broker malpractice case.

In that case, he said, the client argued that it had asked the broker to procure policies that provided defense coverage but the broker did not do so. The broker argued in return that it was the insured’s fault for not being aware of the problem earlier and pointing it out.

Finley Harckham, senior shareholder, Anderson Kill PC

“The court rejected the broker’s argument that the clause required the dismissal of the client’s broker malpractice action, but left open the possibility that it could form the basis of a defense, based upon the client’s alleged contributory negligence in failing to catch the error,” Harckham wrote in a recent bulletin from Anderson Kill.

The case remains in the courts, said Harckham.

He noted that middle-market and small businesses that rely on simple “broker of record” letters are more vulnerable to this difficulty than larger companies that often issue RFPs that specifically lay out their requirements.

Clearly, too, large commercial firms paying millions in premiums typically have written brokerage agreements that spell out the broker’s duties, in part because they prefer to pay the broker a fee rather than have the broker work on commission, he said.

Also, such clients often use brokers for an array of services, which requires a written contract, Harckham said.

Familiarity Breeds Comfort

Having a broker satisfactorily fulfill a risk manager’s requests can depend on the broker’s experience with the account, said Dan Holden, manager of corporate risk & Insurance with Daimler Trucks, North America.

A former brokerage executive who spent part of his career at Marsh, Holden said he is comfortable simply telling his broker — New York-based Frenkel & Co. — what he wants verbally largely because the firm has worked with Daimler Trucks North America since 1981.

“We have never laid out in specifics [in writing],” he said, noting that he has never encountered a problem with the brokerage.

He might act differently, he said, with a broker that had less experience with Daimler’s risks. In that case, Holden said, he would probably carefully spell out his expectations on paper to be sure there were no misunderstandings.

“What you’re doing is transferring the risk to the broker by putting it in writing and asking them to be proactive instead of reactive.” Holden said.

But, he said, Daimler is fortunate enough to have a broker that knows enough to do that anyway.

Dos and Don’ts

From Harckham’s perspective, risk managers should carefully read any brokerage agreement to ensure there is no language that may lead a court to decide the organization is responsible for its broker’s errors.

“Insurance brokers are among the most important suppliers that any company deals with. Yet, often the arrangement between brokers and their clients consists of nothing more than a broker of record letter, or even a verbal authorization to present insurance proposals,” he wrote.

So, what should the brokerage agreement contain? All of the following are critical, he said:

• Language to determine what lines of coverage the broker is authorized to place for its insured and what coverage limits are sought.
• Language clarifying whether the broker will be providing advice and expertise for insurance placements and other services such as claims handling, and
• Language that clearly spells out whether the broker is charging an additional fee for assuming the role of adviser as opposed to simply being an order taker.

Small and medium size companies may have an expectation of receiving advice-based services despite the fact that they are entering into a broker of record arrangements, whereby the broker works on commission and may not provide advice.

“A classic situation here is you have insufficient coverage limits,” Harckham said. He recalled one situation where a factory-owner client wanted first party property insurance and what was procured instead was a very low-limit business interruption policy.

“There was a fire and the loss of income was much greater than the limits of insurance,” he said. The broker argued that it never promised to offer advice, it’s job was just to bind a property-based policy.