Broader Covered Perils Leaves Gaps in Covered Losses under EPL Policies
October 2001
Despite the expansion of covered perils found
within current EPLI forms, there remain a number of provisions that restrict
the scope of covered damages. This article suggests policy modifications and
actions that can mitigate a policyholder's exposure to such uninsured losses.
by Robert A. Bregman
IRMI
Recent years have witnessed significant expansion in the scope of perils
covered by employment practices liability insurance (EPLI) policies. When they
were first offered in the early 1990s, few forms covered much more than wrongful
termination, discrimination, and sexual harassment. But by the mid-1990s, perils
such as constructive discharge, wrongful discipline, and negligent evaluation
had begun to find their way into EPLI forms. Lately, coverage for even more
exotic perils such as "adverse change in the terms of employment" and "wrongful
deprivation of a career opportunity" are appearing within the policies.
Despite these expansions in the scope of covered
perils, there remain a number of gaps in the scope of covered losses under EPLI policies. This
article discusses and analyzes the nature of these losses not covered by the
policies and suggests a number of steps to take that can minimize their effect.
Punitive Damages
The vast majority of EPL policies cover or at least do not exclude punitive
damages. Even the few insurers whose policies exclude punitive damages frequently
offer a buy-back of the exclusion for additional premium. Nevertheless, a significant
gap remains in states where punitive damages coverage is prohibited by law,
such as California. To obtain coverage for punitive damages despite this prohibition,
policyholders should request that a most favored
jurisdiction endorsement be added to their EPL policy.
A most favored jurisdiction endorsement states that with respect to the insurability
of punitive damages, the law of the jurisdiction most favorable to the insurability
of punitive damages will apply, provided it meets one of the following criteria;
it is the jurisdiction where: (1) punitive damages were awarded, (2) where the
act giving rise to the punitive damages award occurred, (3) where the insured
is incorporated or maintains its principal place of business, or (4) where the
insurer is incorporated or maintains its principal place of business.
Application of the Endorsement. The following
scenario illustrates how most favored jurisdiction wording can afford coverage
for punitive damages where it would be otherwise precluded. Company XYZ is incorporated
in Delaware. A female employee alleges that she was sexually harassed while
working in XYZ's California office. The claimant is awarded compensatory and
punitive damages. However, in the state of California, statutory law prohibits
insurance coverage for punitive damage awards. But because XYZ's policy contains
a most favored jurisdiction provision, coverage will apply because in Delaware,
the jurisdiction in which XYZ is incorporated, there is no prohibition of such
coverage.
When the Most Favored Jurisdiction Wording Is Crucial. Inclusion of most favored jurisdiction wording is crucial, if a claim could
be brought in a state prohibiting punitive damages coverage. Accordingly, such
wording is imperative when: purchasing an EPL policy in a state where punitive
damages are not insurable and for insureds that have multi-state operations
and therefore cannot predict where the claims seeking punitive damages will
arise.
Limitations of Most Favored Jurisdiction Wording. First, most favored jurisdiction wording merely modifies the existing level
of coverage for punitive damages already provided by a policy. It does not provide
coverage if punitive damages are otherwise excluded by the policy. Second, the
legality of the provision has not yet been tested in court. Nevertheless, if
an EPL policy is going to be written with coverage for punitive damages, the
most favored jurisdiction endorsement should be requested, if it is not already
incorporated within the policy. (Note that a handful of EPL forms on the market
today include most favored jurisdiction wording as a regular part of the policy.)
Amounts Owed under Employment Contracts
Virtually all EPL policy forms preclude coverage for monies owed for breach
of employment contracts. Many of the policies also specify that such monies
include: commissions, bonuses, profit sharing, or any other benefits enumerated
in the employment contract. Few, if any insurers will remove this restriction.
Important Modifications. Regardless, policies
should be specifically modified to include wording that: (1) provides coverage
for the defense of breach of employment contract claims, and (2) states that
the exclusion only applies to claims involving employment contracts for a "specific
duration" (i.e., the traditional employment contract). This distinction is important
because many claims for wrongful termination are based on implied contracts of employment, as indicated
by employee handbooks or initial letters offering employment. Plaintiff's attorneys
often state that such documents create implied contracts of employment between
their client and the defendant corporation. Such circumstances should not be
excluded because nearly all allegations of wrongful termination indicate the
existence of these "implied" contracts of employment.
Amounts Owed under Wage and Hour Laws
Virtually all EPLI policies exclude coverage for wage and hour claims. Such claims most commonly
arise from an employer's alleged failure to pay overtime to what should have
been treated as nonexempt employees. All employees are either "exempt" or "nonexempt."
Although those terms have many implications, the most important is that exempt
employees need not be paid overtime. Wage and hour claims most often occur when
an employee complains to an attorney about not getting paid overtime, who then,
after the interview, realizes that he may have a six-figure class-action claim
on his hands.
The exclusion of wage and hour claims became an issue of urgent concern on
July 10, 2001, when a California jury returned a $91 million verdict against
a company (Farmers Insurance) that had improperly classified its claims adjusters
as exempt. After interest costs and attorneys fees are added, the true cost
of the verdict may exceed $130 million. This verdict follows other notable,
recent wage and hour settlements, including: Rite Aid ($25 million), U-Haul
($7.5 million), and Taco Bell ($13 million).
There is an overtime exemption for executive, administrative, professional,
and outside sales employees under the Fair Labor Standards Act (FLSA) and most
state guidelines. To be exempt, these employees must meet certain tests regarding
job duties and responsibilities and be compensated "on a salary basis" at not
less than stated amounts. However, such tests are often confusing. Indeed, the
issue of who is an "exempt" employee is not always clear-cut.
Loss Prevention. Despite the fact that EPLI
policies almost universally exclude coverage for wage and hour claims, an insured
can take a number of steps to prevent or at least minimize the risk of suffering
an uninsured loss of this kind, especially when there is a question as to whether
an employee is exempt or non-exempt. These steps include: keeping records of
employees' hours, restricting the employees to non-overtime hours, and hiring
new employees with the specific understanding that they are exempt.
In some cases, an employer might consider settling individually with each
employee who has a potential claim, asking the employee to estimate the amount
of overtime he or she has worked over the past several years. This approach,
while affording finality, is costly, and is not recommended unless the organization
has first consulted with an experienced labor attorney.
An Important Exception to the Wage and Hour Exclusion. Although there is not much an insured can do about the standard wage and hour
exclusion, wording should be requested that modifies the exclusion so that it
does not apply to claims associated with the federal Equal Pay Act of 1963.
This law, which prohibits sex-based discrimination in determining the wages
of male and female employees, mandates equal pay for both sexes when work involves
equal levels of skill, effort, and responsibility and does not involve the types
of wage and hour claims already discussed. However, absent a clarifying endorsement
to this effect, an insurer could stretch the intended scope of this exclusion
so that it extends beyond prohibiting merely a garden-variety wage and hour
claim.
Severance Payments
Another type of loss commonly excluded by EPL forms is severance payments.
For example, employees not terminated for cause, as is generally the case in
a typical layoff or corporate downsizing, typically receive some form of severance
payment, generally ranging from 2 weeks to 1 year of salary. Exclusion of such
payments is appropriate because such costs are essentially business risks rather
than purely fortuitous events (i.e., given a downturn in business, employees
must sometimes be laid off).
Severance versus Front Pay. However, a handful
of EPL policies exclude what is known as "front pay." In contrast to severance
pay, these monies represent funds that an employee would have received had he/she
not been wrongfully terminated. Since only 5 to 10 percent of all EPLI forms
exclude front pay, such exclusions should be vigorously resisted. This is especially
true considering that front pay could represent payment for many more years
of lost wages than does severance pay (e.g., a wrongfully terminated 35-year-old
who is unable to find similar employment could conceivably be awarded 30 years
of "front pay.")
Concluding Thoughts
Despite the expansion of covered perils found within current EPLI forms, there remain a number of provisions that restrict
the scope of covered damages. The policy
modifications and actions suggested within this article can mitigate a policyholder's
exposure to such uninsurable losses.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.