Expert Commentary

Broader Covered Perils Leaves Gaps in Covered Losses under EPL Policies

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.


Professional, D&O, and Fiduciary Liability
October 2001

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. Expert Commentary articles and other IRMI Online content do 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.

Like This Article?

IRMI Update

Dive into thought-provoking industry commentary every other week, including links to free articles from industry experts. Discover practical risk management tips, insight on important case law and be the first to receive important news regarding IRMI products and events.

Learn More



Register now for AgriCon Des Moines
Get Started IRMI Sidebar Ad
Featured Video
 

Featured Products

Quality Risk Management Fieldbook

Quality Risk Management Fieldbook

This step-by-step guide is not a textbook but is the perfect resource if you lead a small business, nonprofit, government entity, or political subdivision and do not have risk management expertise or staff. Everything is included to help you work alongside your insurance agent to protect and preserve your organization. Learn more.

IRMI Glossary of Insurance and Risk Management Terms

Glossary of Insurance and Risk Management Terms

This best-seller from IRMI gives you quick answers to questions involving unfamiliar insurance terminology. The definitions are written in plain English with a focus on practical application. Learn more.

Navigation

Social Media

User ID: Subscriber Status:Free