Insurance Agent Liability in Katrina Litigation

January 2007

A review of cases in the U.S. District Court, Southern District of Mississippi, indicates that insurance agents are attracting a considerable amount of attention from plaintiffs. Unlike insurance company defendants, whose cases will most likely be tried in federal court (the preferred venue for defendant insurers), many agents will appear in state court.

by Tim Ryles, Ph.D.
Tim Ryles Consulting

Companies and their producers may end up in different venues because of provisions in federal laws creating the National Flood Insurance Program (NFIP) and the nature of the pleadings. Under federal law, matters related to improper administration or adjustment of claims under the NFIP are issues falling exclusively under federal jurisdiction. Questions relating to procurement of flood insurance fall within the state's authority.

A recurring theme of agent cases is the allegation (denied by agents) that "My agent told me I didn't need flood insurance." In Carr v. David Denison and Nationwide Mutual Fire Insurance, for example, the Carrs contend that agent Denison specifically advised them against purchasing flood insurance. Relying on this advice, the Carrs did not purchase flood insurance and suffered losses during Katrina. Other cases contain similar charges.

Perhaps the best known case is Leonard v. Nationwide. In Leonard, the agent advised against purchasing flood insurance "unless they (the Leonards) lived in a flood prone area (Flood Zone A) where flood insurance was required in connection with mortgage loans." Since there was "no evidence in the record establishing the standard of care applicable to an insurance agent who is asked about the advisability of purchasing flood insurance," the court drew no conclusions about agent negligence. Further, the court could find no evidence in the record pertaining to the "standard of care for the training of insurance agents who are authorized to sell and interpret flood insurance policies." The decision does not address the issue as to whether the agent's actions should have been addressed in state as opposed to federal court.

Standards Applicable to Agent Liability

Leonard may represent a roadmap for plaintiffs who harbor ill feelings about agent conduct. For example, Leonard suggests that to hold agents liable for negligence, insureds are advised to present evidence of agent training about the flood insurance program, agent duty to advise, and general standards of care expected of insurance producers in Mississippi.

Tests for agent liability may be viewed as a continuum. At one extreme is agent as order taker in which the agent—purchaser relationship is strictly a commercial one and liability for negligence is extremely unlikely. At the other extreme is a fiduciary role in which the agent's duty is to act in the best interest of the insured. A fiduciary relationship will most likely support a liability allegation. At some point along the continuum is a "special relationship" with an insured. This is "A nonfiduciary relationship having an element of trust, arising especially when one person trusts another to exercise a reasonable degree of care and the other knows or ought to know about the reliance." (Black's Law Dictionary, 7th ed.)

Black's defines reasonable care as "the degree of care that a prudent and competent person engaged in the same line of business or endeavor would exercise under similar circumstances."

According to Webster's New World College Dictionary, prudent means "capable of exercising sound judgment in practical matters, esp. as concerns one's own interests; cautious or discreet in conduct, circumspect, not rash." Competent means "well qualified; capable; fit."

The definition of reasonable care is in the conjunctive (prudent and competent).

While defenses of "it is custom and practice in the industry" are often raised on behalf of agents, i.e., the agent acted as everyone else in the business of selling insurance acts, unless custom and practice conform to standards of prudence and competence, this defense will probably fail. Persons who doubt this only need to recall New York Attorney General Eliot Spitzer's attacks on a widespread custom and practice in the industry relating to contingent commissions. Other examples abound.

The actual character of the agent-insured relationship, however, is a fact driven determination based on the nature of the relationship and not necessarily on how long the parties have dealt with one another. The pursuit of several questions aids in determining where the relationship rests along the continuum.

• Is the agent independent or captive? Independent agents exercise more discretion and may be viewed as agents of the insured more often. Captive agents who own stock in their companies or who benefit from employee benefit programs may be attacked for conflict of interest.

• Is the agent a broker? (Brokers typically represent the insured and must satisfy a heightened standard of duty to the insured.)

• Did the agent receive a fee for advice given to the insured? Additional fees trigger a likelihood of liability.

• Does the agent advertise that he is an expert or specialist? Agents often refer to their professionalism without considering the implications. Professionals are held to a higher standard than nonprofessionals. Further, it is not necessary for an agent to be a professional. Merely leading people to believe an agent assumes a professional status may be sufficient. My guess is that Web pages and Yellow Page ads are receiving close scrutiny in Mississippi.

• Has the agent made insurance decisions for the policyholder in the past?

• Did policyholder expressly assign certain duties to the agent or insist upon certain endorsements? An instruction to be sure that "I am fully covered" or to secure flood insurance for my home and contents" if not done can spell trouble for agents.

• Did the agent conduct a risk analysis to determine what coverage to suggest? A positive response to this question can harm an agent's defense.

• To what extent did the policyholder rely on the agent in selecting coverage? Reliance, of course, is usually essential for plaintiffs to win.

• Should the agent have known that the insured relied on her opinions and recommendations? This is another hurdle facing plaintiffs and highlighting the necessity of examining the nature of the insured and agent relationship.

• Is there a longstanding business or personal relationship between the agent and the policyholder? A "yes" adds to the probability of liability.

• How many other policies have been sold to the insured by the same agent or agency? This question may be a measure of the intensity of the relationship issue.

• How many meetings and discussions occurred between the agent and insured on the policy in question? Similar in nature to the preceding question.

• What is the insured person's level of sophistication about insurance? And are the insurable risk exposures reasonably within the common understanding of the insured, or do they require special knowledge? Greater dependence on the selling agent increases the probability of establishing a special relationship.

• Did the agent make use of any illustrations or other materials during the sale? This is a double-edged sword. Failure to present evidentiary materials about the policy and coverages may be construed as negligence. Presenting documents that have a capacity or tendency to deceive, on the other hand, may prove equally disadvantageous for agents.

• Did the agent receive any special training on any of the potential risk exposures? Failure to train suggests negligence. Moreover, if an agent received training but her conduct failed to show that it took, the training entity (usually an insurer) may be off the hook, but the agent will have a problem

Answers to these questions will assist fact-finder juries to determine whether the relationship is one in which the agent can be held liable for failure to meet the requisite standard of care.

Additional Sources Addressing Agent Standards of Care

Recent developments in agent training, especially the emphasis on mandatory courses covering principles of ethical behavior, may create problems for agent defendants. Agents are required to take continuing education courses. The course materials and the instructors are approved by the state Departments of Insurance. In essence, an agent's schooling represents a form of state action. Consequently, what agents are taught, as suggested by the court in Leonard, should be of interest to the courts. Certainly, the printed material on which this training is based will likely be subjects of discovery and close analysis as Katrina cases proceed. To illustrate its relevance to Judge Senter's suggested queries in Leonard, I cite the following examples from The Market Conduct Handbook for Agents published by BISYS Education Services which, inter alia, includes the following admonitions to agents:

• Agents have professional and fiduciary responsibilities to insureds.

• Agents have a duty to evaluate a client's insurance needs and to make proper recommendations about insurance (Note: The term "client" implies a more than casual relationship between insureds and agents. Professionals have clients; nonprofessionals have customers.)

• Failure to cover an insured's need, thereby creating a gap in coverage, can result in a valid legal claim against an agent.

• Erroneous advice that something is covered when it is not can result in a valid claim against the company, which, in turn, can recover from the agent.

• An agent must clearly explain policy provisions including what is covered and what is not, to ensure that there are no misunderstandings at claims time.

• After meeting with a client, agents should always document the final outcome as a record of what was discussed, what was recommended, and what the client chose to buy.

In some respects, the standards appearing in the training material on ethical practices are ahead of common law relating to agent conduct. In effect, then, there may be two sets of standards; what the common law of the state recognizes and what the state-approved training materials teach. To use a track and field analogy, the former is a low hurdle; the latter, a matter for pole vaulters.

A Closing Example

As indicated above, some plaintiffs allege that an agent advised them that they did not need flood insurance. Assume for sake of argument that the basis for the recommendation is that the property was not located in Zone A. One problem with the recommendation is that NFIP's publication, "Myths and Facts about the National Flood Insurance Program," begins with the following: "WHO NEEDS FLOOD INSURANCE? EVERYONE." (Emphasis added.) NFIP further reports that 20 to 25 percent of all NFIP paid claims are for property outside areas with the most significant risks of flooding.

With this information available to agents, would a prudent and competent agent recommend against buying flood insurance? Are these facts material? Should a prudent and competent agent know these facts? Shouldn't a prudent and competent agent at least share the NFIP information with clients? Is an agent who is unaware of this information incompetent, thereby failing the competency test, and unable to act prudently as a result? If an agent is aware of this information but does not disclose it, is that an affirmative act of omission? My guess is that if courts are open to examinations of agent training materials (as the language in Leonard suggests) a broadened sense of duty may be imposed on Mississippi agents. Introducing evidence about agent training may further serve to bring common law and regulatory sanctioned standards more closely in alignment.

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For more information, see the September 2007 article, Rethinking Concurrent Causation and the Flood Exclusion: Further Comments on Katrina-Related Coverage Disputes.

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