Can We Just Forget about the $100?
June 2006
A firm's risk manager, as its employee, has
a duty of loyalty to that firm and its owners to act in their best interests.
That same risk manager, as that firm's legal agent in dealing with its insurers,
has a duty to act with utmost good faith toward these insurers.
by George
L. Head, Ph.D.
American Institute
for CPCU
At times, a risk manager's duty of loyalty to his or her employer may seem
to conflict with the employer's (and hence the risk manager's) duty of utmost
good faith to the employer's insurers. Consider the following hypothetical situation,
which ultimately turns on the true significance of a $100 payment made neither
by nor to any insurer.
Smithfield Homes, Inc. develops large tracts of homes on private islands.
To market these homes even before they are built, Smithfield invites prospective
buyers on cruises to particular islands Smithfield already owns, asking each
prospect to select a specific property and to choose the model of Smithfield
home they agree to buy on that site.
Enter—and Exit—the Warbucks Men
Two prospective buyers are Sam and Junior Warbucks, a father and son, aged
60 and 30, both wealthy major stockholders in defense contracting firms, each
with a wife and children. To get the jump on their fellow prospects on this
particular Smithfield cruise, Sam and Junior take action as soon as the whole
cruise group arrives. Skipping the initial group orientation, the Warbucks seek
out a Smithfield foreman and arrange to have him take them on a private sunrise
boat trip to the specific island the Warbucks think they will particularly like.
The foreman asks a Smithfield sales representative's permission to make this
special trip with the Warbucks, and the representative says, "Go ahead."
The foreman then selects a 20-foot outboard which he mistakenly believes
is owned by Smithfield Homes, but actually the boat is abandoned property, recently
left by some unknown visitors. Without anyone else knowing, the foreman asks
Sam for $100 cash in advance for the foreman's extra efforts and "to keep this
early-morning trip confidential." Sam gladly gives the foreman two $50 bills.
Unfortunately, on the way to the island, the foreman steers the outboard
recklessly, crashing the boat hard into some rocks, and killing both the Warbucks.
The foreman survives, conscious and floating, but with two broken legs.
Enter Justin Case
When Justin Case, the aptly named corporate risk manager for Smithfield Homes,
learns what has happened, he realizes that there can be some problems with Smithfield's
workers compensation insurance as well as perhaps its commercial general liability
(CGL) coverage. With respect to workers compensation, the foreman appeared to
the Warbucks to be an employee authorized to represent Smithfield Homes, but
in fact he may have been acting outside his duties, regular working hours, and
normal workplace. Furthermore, the sales representative's apparent permission
may or may not have been legally operative. In fact, whether the foreman qualified
for workers compensation could ultimately well be a question for some lawyers
and a jury.
As for the wrongful death or bodily injury liability claims the Warbucks
widows would soon bring against Smithfield Homes for the deaths of their husbands,
Justin was anxious to review the relevant insurance policy limits and language.
New to Smithfield and its first employee with the title and duties of risk manager,
Justin was concerned when he learned that Smithfield had no ocean marine insurance
and that the company's umbrella liability policy had per-person and per-occurrence
limits of only $1 million.
Justin felt better, however, when he found that Smithfield's basic CGL coverage
(Insurance Services Office, Inc. (ISO), 2003 form CG 00 01 12 04) had a $2 million
per-person and a $5 million per-occurrence limits. I, George Head, have carefully
condensed and edited the policy, using brackets as needed for clarity. The first
sentence is a broad insuring agreement, the second a general exclusion from
that agreement, and the third an exception to the exclusion. This third sentence,
restoring some coverage, may well be crucial in this situation. This policy
read, in pertinent part:
- [The insurer] will pay those sums that the insured [Smithfield] becomes
legally obligated to pay because of bodily injury or property damage to
which this policy applies…. [But t]his insurance does not apply to bodily
injury or property damage arising out of the … use … of any watercraft …
owned by any insured. [However], this exclusion does not apply to any watercraft
[the insured does] not own, that is less than 26 feet long, [and that is]
not being used to carry persons or property for a charge.
Justin read these words several times, interpreting the facts as he then
knew them. He considered carefully what he should do and how he should approach
the Smithfield's workers compensation and general liability insurers. Justin
knew he had a dual obligation: on one hand, to act in the best interests of
Smithfield's stockholders and, on the other, to fulfill Smithfield's duty to
act with utmost good faith toward these insurers. Remember (and this is crucial
to the ethical questions that follow) at this point in time, the foreman who
recklessly crashed the outboard was the only person alive who knew that Sam
Warbucks had paid a fee to transport people in that 20-foot boat which was not
owned by Smithfield Homes and therefore was not covered by Smithfield's insurers.
As yet, Justin had no inkling of this payment.
In telling Smithfield's workers compensation insurer about the foremen's
broken legs, Justin decided that he would offer the opinion that the foreman's
claim was problematic. Much depended on whether the sales representative had
real or apparent authority to give the foreman the Smithfield company's permission
to take the Warbucks men on that short but fateful boat trip. Justin also thought
it best to suggest to the foreman that, if he had not already done so, he should
get a lawyer to help with his claim because "things might get complicated."
This suggestion might help the foreman and also protect Smithfield from any
later "bad faith" suits.
For Justin, on the basis of what he knew in the days right after the Warbucks
were killed, there was no question that Smithfield's general liability insurer
should provide legal defense, and pay up to its policy limits, for the negligence
or wrongful death claims the Warbucks widows and children surely would bring
against Smithfield. He would remind this insurer that these claims fell within
an exception to the watercraft exclusion in the CGL policy. (Justin thought
it unlikely that the Warbucks would sue the foreman personally because the foreman
was not a promising defendant. So Justin decided to offer no opinion on what
this liability insurer should do with respect to the foreman.)
Within the week, Justin did as he had decided on these two matters. He also
set to work getting Smithfield ample limits of ocean marine liability insurance—coverage
that certainly would have help in this situation, without having to rely on
an exception to an exclusion in Smithfield's CGL policy. Justin felt he has
done the right things to cost-effectively safeguard Smithfield while also acting
with utmost good faith toward its insurers.
Justin's Dilemma
But 6 weeks later, Justin's personal satisfaction in a job of risk management
well done shattered. It shattered when Justin paid a weekend visit to the injured
foreman, who was recuperating in a rehabilitation center. This was also during
a time when Smithfield's general liability insurer was preparing its defense
against the against the $10 million suit the Warbucks widows had just brought
against Smithfield for negligence leading to their husbands' deaths.
In casual conversation with Justin, the foreman mentioned that he still felt
guilty about not giving the Warbucks men the kind of ride for which Sam had
paid him $100. He regretted that they never got to see the properties on which
they so wanted to build. The foreman asked Justin to himself give each of the
widows a $50 bill as a personal token of condolence from the foreman; the foreman
promised he would repay Justin later. Stunned, Justin agreed to the foreman's
request.
Justin was stunned because, without realizing the import of what he had said,
the foreman created an ethical dilemma for Justin. For the first time, Justin
realized that a fee had been paid for the boat
ride on which the Warbucks died. So the Smithfield's CGL insurer arguably
had contractually valid grounds for denying the widows' claims, even for refusing
even to mount a legal defense against them. To act with ultimate good faith
toward this insurer, Justin had an ethical duty to tell this insurer what he
had just learned. But doing so could well cost Smithfield over $10 million in
defense and settlement costs.
"Wait a minute!" Justin mumbled to himself. Only he recognized the legal
significance of what the foreman had told him. Did he have to tell anyone else?
Chances are the foreman would never mention it again, especially if Justin just
quietly gave each of the widows $50 as a token condolence payment on the foreman's
behalf. And none of the claims people or lawyers for Smithfield's CGL insurer
would likely to ask the foreman about this or any other payment.
And wait just another minute, Justin thought, as the policy wording burned
in his mind. Liability coverage did apply to small boats the insured did not own when "not
being used to carry persons or property for a charge." That's exactly
what the policy said, Justin thought. On its face, the policy did not say anything
about by whom, to whom, or for whose benefit there was a charge, or even that
any fee was actually paid—only that there was a charge for transportation.
Resolving Justin's Dilemma
Justin hoped he was right in this interpretation. Even more, at that moment
he wanted to believe that no one else would ever ask or find out about Sam's
paying the foreman. Justin really wanted the payment to be irrelevant to the
policy rights and duties of both Smithfield and its CGL insurer. Then, if the
payment were legally irrelevant, Justin could ethically just stay quiet, could
act in the best interests of the Smithfield stockholders without violating his
and Smithfield's duty of utmost good faith toward the CGL insurer. He could
keep secret, and hope it would stay secret forever, the indisputable fact of
Sam's payment to the foreman. But if he were wrong, if Sam's payment really
created a sound defense for the insurer, and it came out that Justin knew of
this defense but had consciously decided to say nothing to anyone, Justin feared
that no insurer would be likely to ever really trust Justin again, and no firm
would ever really want him as its risk manager.
Should Justin talk to anyone about this dilemma and the fears it gives him?
If so, to whom should he speak, and what should he say?
My personal answers are that Justin should tell the whole truth, as he now
knows it, to everyone concerned. He should start by telling Smithfield's top
executives that he has just learned of Sam Warbucks' payment to the Smithfield
foreman and that, just possibly, this payment, requested by the foreman, may
jeopardize Smithfield's general liability coverage against the claims of the
Warbucks widows. Justin should then tell Smithfield's senior management that—unless
they order him not to do so—Justin thinks it best that he tell the CGL insurer's
claims adjuster that he now knows about Sam's payment to the foreman. Justin
may leave it at that, leaving the insurer's claims people to scratch their heads
about why Justin brought this payment up now. Alternatively, Justin may choose
to say why he believes this payment does not release the insurer from its defense
and payment duties.
I choose—we should all choose—full disclosure as the most effective, most
ethical, and in the long run safest, resolution
of such dilemmas. Except perhaps in the extremely unusual case where secrecy
(even lying to a war-time enemy) saves endangered innocent civilian lives that
cannot otherwise be rescued from immediate peril, the truth is best—even if
the truth gives the insurer an "out" and lowers an insured's profits.
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