Archive for March, 2009

Real Estate E&O Claims on the Rise

Thursday, March 5th, 2009
by Mike W. Smith, President

In July of 2007 I wrote an article about the rise of E&O claims related to the Real Estate industry.  We are still seeing an increase in reported E&O claims. There are a number of factors contributing to this trend, including:

1. Collapse of the Sub Prime market.
2. An increase in the stock market as investment dollars shift from real estate to equity investments.
3. Increase in interest rates.
4. Increase in foreclosure rates, both personal and corporate.
5. Stall of the residential real estate sales in major U.S. markets.
6. A slow down in the growth of increased rents.

Below are descriptions of some of the more significant areas of claims we have seen.

Mortgage Brokers
These claims relate primarily to suitability. Many E&O policies specifically exclude these types claims. Allegations contend that the underlying mortgages should have not been issued, given the financial creditworthiness and ability of the borrower to repay the related loans. When the borrower cannot repay loans, suits arise from the borrower, lender and others. These claims relate both to residential and commercial clients. Our largest mortgage broker claim is related to a commercial loan and is a $5 million claim, involving the mortgage broker and the real estate agent.

Commercial Real Estate Agents
These claims relate to practically every area of a real estate transaction. In several instances our broker was sued because a property failed to achieve a sales or rental price consistent with expectations. One recent claim involving this issue involved a suit for $20+ million. The case was ultimately dismissed against our broker; however, in excess of $200,000 was spent defending this claim and it was recently appealed. Another similar suit in our office was for $8 million and is still in litigation. Some of the more frequent claims involve the following:

a. Suitability of purpose claims. These claims can relate to improper zoning, easements or ADA related issues. In these cases, a property cannot be used for its intended purpose. This is a significant risk in land sales. Our largest claim relating to this issue was for $26 million.

b. Discrimination. These claims involve both residential and commercial clients. These claims frequently relate to property management or dual agency claims. Our largest claim relating to this issue was over $1 million.

c. Dual Agency. These claims can occur in any real estate transaction where dual agency is involved. Dual agency refers not only to the same agent, but also the same Firm with different agents. Our largest claim for this issue was in excess of $1 million.

d. Commissions. Many of our brokers bring suit against their clients in order to collect commissions owed. These suites almost always involve countersuits of negligence. Our largest claim for this issue was $23 million.

e. Corporate Services. Many of our commercial real estate clients step out of the box and perform non traditional consulting services. Often times the contracts are not tight and the agents are not qualified to perform the related services. To date we have had several claims in this area, however, most were less than $500,000. Many policies do not cover these services.

f. Pollution. Many of our broker clients are brought into suits relating to failure to disclose a contaminant which may include lead, asbestos, mold, etc. These claims typically involve failure to disclose by an owner which is imputed upon their agent. Our largest claim relating to this issue was over $5 million.

g. Owned Property. Most of our commercial real estate clients are involved in managing company or principal owned properties. Claims arise in the conflict of interest between ownership and management. We have had dozens of claims relating to this issue ranging from $35,000 to in excess of $1 million. Most policies do not cover these services.

h. Buyer/Lesser Financial Creditworthiness. These claims relate to the inability of a tenant or buyer to fulfill their financial obligations as a buyer or tenant. The claims address the issue of whether the broker has a responsibility to properly qualify a buyer or tenant and what obligation they have to disclose such information. Our largest suit for this is in excess of $50 million, however we have several down to as low as $250,000.

Posted in Real Estate | 4 Comments »

Owned Property Issues for Commercial Real Estate

Thursday, March 5th, 2009
by Mike W. Smith, President

Many of our larger commercial real estate clients are involved in businesses other than their primary real estate brokerage.  Often our commercial real estate clients will create one company for property management, one for real estate sales and leasing and then also multiple joint ventures and partnerships which own real estate or interests in real estate.  Several insurance related issues occur in this situation.  I have addressed some of them below:

Most E&O policies exclude coverage for services provided relating to owned property.

If your company provides professional real estate services for one of these related companies, or a piece of property where any “insured” has a financial interest, then you may have a gap in your E&O coverage.  There is an inherent conflict of interest between an owner of a piece of property and that of a real estate broker who should independently represent a third party.  That conflict of interest is a fine line which is often crossed when an individual or Firm is on both sides of a transaction.  This is a similar conflict to that of a dual agency, however, insurers look at it less favorably. Courts look at it even less favorably.

Owned property exclusions in an E&O insurance policy usually apply not only to the Company, but its principals, employees and also independent contractor sales personnel.  Basically anyone covered as an “insured” on the policy.  Some companies may find themselves without any coverage for the sale of a piece of property owned by a sales agent, even if the company didn’t know that the agent had any financial interest in the related property.  This can be a big problem with any large real estate brokerage.

Take the example of an independent contractor sales person (IC) that has a 33% ownership interest in an LLC that owns a building with their best friend.  The IC sells the property as the licensed agent and a third party sues the brokerage. The suit will not only be against the agent, but also the brokerage that is responsible for the agent. Under most E&O policies the brokerage would not have any E&O insurance protection because of the ownership interest of the agent.
Common misconceptions regarding owned property exclusions in an E&O policy:

1. Property Owned by a family member is not owned property

2. The Company doesn’t own any properties, people do.

3. The ownership interest is in an LLC. The LLC owns property.

4. Ownership Interest is only a small percentage

Although policy provisions vary by carrier, each of the above owned property scenarios would cause a resulting claim to be excluded under most real estate E&O policies.  The exclusions in most policies include the wording directly or indirectly.  We encourage our clients to review their policy provisions very carefully and to call us to discuss any issues or concerns.

How can I help protect my brokerage in owned property transactions?

1.    Develop a written policy for requiring all agents\personnel to disclose in writing to the Company any listings (sales, lease or Property Management) for which they have a financial interest.  This would include owners, principals and other employees.

2.     Develop a similar procedure for transactions where your agents are not the listing agent.

3.     Develop a procedure and policy for informing all parties to a transaction of any financial interest.

4.     If your Brokerage has exposure, you should review your current E&O policy to determine how or if your E&O policy addresses this exposure.

Sale of Joint Venture Interest is not the sale of real estate.
Most of our clients form Limited Liability Companies (LLC’s) for the purpose of buying and selling real estate.  They own the LLC and the LLC owns the property.  This is often done to insulate owners from liability associated with the property and for tax purposes.  An insurance issue arises if real estate agents sell the ownership interests in the LLC as opposed to the underlying real estate.  It may appear on the surface to be the same thing, but from an insurance perspective it is not.  Selling the interests of a LLC is tantamount to selling a business, which is excluded from most E&O policies.

Posted in Real Estate | 2 Comments »

Subprime Market Issues Affect Insurance

Thursday, March 5th, 2009
by Mike W. Smith, President

Two years ago I addressed a group of Professional Liability Underwriters in a panel entitled “E&O and the Real Estate Bubble.”  At that time I was criticized for predicting an insurance crisis related to real estate E&O.  In hindsight, I was not that far off.  The current mortgage meltdown and foreclosure issues affect more than just the housing market. Foreclosures are at an all time high, in many markets real estate values are on decline and E&O claims are on the rise.  These circumstances have an adverse affect on the Property & Casualty Insurance market as well as the coverage and pricing offered.

The current subprime crisis has created several insurance related issues among our clientele which I would like to bring to your attention.  As professional liability claims relating to falling real estate prices, foreclosures, investment sales and creative financing strategies increase, we are beginning to see signs of a hard market for real estate professionals, as it relates to Professional Liability Insurance (E&O).  On the surface, this appears to be a residential real estate issue, however it really affects all real estate professionals as carriers paint a broad brush in real estate E&O policies and underwriting guidelines.  I have highlighted some of the more significant issues below.

1   Carriers are adding exclusions for services previously covered.

In response to the credit/subprime/foreclosure crisis, we are seeing renewal policies which contain significant exclusions relating to predatory lending, subprime exposures, investment sales and high loan to value transactions.  These exclusions relate to both commercial and residential real estate professionals. The exclusions further extend to mortgage brokerages, title agencies and appraisers to name a few.  Many of our commercial real estate clients don’t provide such services, but are being brought into the related suits and these exclusions preclude coverage even if its only defense.

2   Claims reported under “claims made” policies will have coverage based on the current policy terms and conditions  which may exclude services previously covered.

This is the single biggest issue we are facing.  When carriers change policy terms, those terms apply to any new claims submitted regardless of when the professional service was rendered.  Take the example of a policy which covered subprime loans in 2007 and was renewed with the same carrier, but the new policy had an exclusion for subprime loans.  The new policy would not respond to the claim, even though coverage for that service was in place when the service was provided.  It is the nature of claims made polices.  You should be very careful and examine any changes in policy terms and conditions upon renewal.  Depending upon the state and type of carrier, they may not be required to give you advance notice.

3.   Carriers are exiting the market again.

Insurance carriers go in and out of markets in search of profitability.  This creates hard and soft markets. We are seeing many carriers stop writing real estate risks altogether as a reaction to the economy and the financial markets.  Other carriers are exiting specific markets such as California.

4    Premiums are beginning to increase after three years of stagnant or decreasing premiums.

Several years without national disasters combined with record profits for P&C insurance companies have created an influx of new carriers over the past two years.  This influx has helped to keep premiums at a relatively low rate, despite a significant increase in claims activity.  We are beginning to see carriers increase premiums as their professional liability profits must stand on their own. Additionally, some of these new players that tried to seize the market are now pulling back.

So what can you do?

1.  Work closely with your agent on your E&O renewal and discuss all your services and options.

2.  Send in your E&O application early (at least 30 days) so as to allow your agent to properly market and evaluate your options.  If you wait until the last minute you may not be able to obtain other options.

3.  Review your quotes and your policy very carefully.

4.  Report any known matters or incidents to your current carrier as soon as you are made aware of them, and in all circumstances prior to your policy’s expiration date.  Some policies allow you to report incidents as claims before you are actually brought into a suit. You should check your policy to determine the proper claims/incident reporting procedures.

5.  Consider purchasing an Extended Reporting Endorsement if warranted.

Extended Reporting Endorsements

Most claims made policies provide an option to purchase an additional amount of time for which to report claims which occurred during the policy period, but are not reported to you until sometime in the future.  It is possible that given the market, the only way to cover certain prior services will be through the purchase of an Extended Reporting Endorsement (Tail Coverage).

Different carriers have different provisions regarding this.  Often you can purchase a minimum of an additional 12 months up to 36 months of extended time to report a claim.  A few carriers will allow for a longer period under certain conditions.  The premiums for an extended reporting endorsement are based on the expiring premium and range from 75% to 100% of the expiring premium for 12 months and up to about 250% of the expiring premium for 36 months.  This premium is in addition to any new premium you would have on the new policy

Summary

As with any E&O policy we encourage you to work closely with your agent to decide what coverage options are best for you. Please take the time to review your E&O renewal very closely and consider your options both relating to past and to future professional services.

Posted in Real Estate | No Comments »

Failure to Remit Premium

Wednesday, March 4th, 2009
by Mary Salerno, National Accounts Manager

An insurance agent E&O claim that is becoming more common, relates to a an accounting error where the agent collected a deposit or premium and inadvertently failed to send it to the insurance carrier.  Most insurance agent’s E&O policies contain an exclusion for claims relating to such an error.  Exclusions may include remitting premiums, return premiums, commissions, brokerage fees or tax monies.  Accounting mistakes happen.  The wrong policy could leave you unprotected.

Unfortunately many insurance agents do not read their own policies.  They may spend hours negotiating coverage features for their own clients and yet leave themselves and their agency with significant gaps in coverage.  We find insurance agents and brokers often expect that their insurance agents E&O policy will cover them for any negligent act.  However,  this is not always true.  If they collect a premium and their bookkeeper fails to remit it to the insurer on time, this is one negligent act often overlooked in an insurance agents E&O policy.

A common exclusion found in insurance agent’s E&O policy is as follows:

“This policy will not pay for any claims based upon, arising out of, attributable to, or directly or indirectly resulting from the failure to collect, pay or return premium.”

We believe that an exclusion such as this can be detrimental to an insurance agency even though it is completely unrelated to their competence in placing proper coverage.  Bookkeeping errors happen.  Don’t let yourself be unprotected.

Example:
An insurance agent sells an extended reporting endorsement which must be paid to the carrier within 30 days.  The client doesn’t pay the premium for two weeks and the bookkeeper is out on vacation for two weeks.  No one thought to follow up to make sure that the premium was paid.  In this case the client lost the right to purchase the extended reporting endorsement because the premium was not paid on time.  If the insurance agency does not have the proper coverage it could be left completely unprotected.

What can I do?

We believe that insurance agents should not be their own insurance agents.  Similar to plaintiffs should not be their own attorneys.  We have been very successful in enhancing our client’s policies to provide coverage for this type of exposure. Wording Not Recommended  One of our licensed professionals would be happy to review your policy and offer suggestions on how to improve your coverage.  We have a few pointers below:

Wording Not Recomended

Exclusion:
“for any claims based upon, arising out of, attributable to, or directly or indirectly resulting from the failure to collect, pay or return premium.”

Wording Recommended if claims relating to premium monies are excluded:

Exclusion:
“for any to any Claim for premiums, return premiums, commissions, brokerage fees or tax monies. However, this Exclusion shall not apply to the failure of the Insured to remit premiums that the Insured has collected.”

Posted in Insurance Agents | 5 Comments »

Bodily Injury/Property Damage Exclusions

Wednesday, March 4th, 2009
by Mary Salerno, National Accounts Manager
Most Insurance Agents E&O policies contain some type of exclusion for bodily injury and property damage claims.  Insurance agents and brokers typically do not expect their E&O policy to cover claims for bodily injury and property damage (BI/PD), however, they do expect their E&O policy to cover claims for wrongful acts in placing or failing to place insurance policies on behalf of their clients.

The language found in your E&O policy’s bodily injury and property damage (BI/PD) exclusion may determine whether your E&O claim is paid or denied. Many E&O policies contain an exclusion such as the following:

Excludes claims “based upon, arising out of, attributable to, or directly or indirectly resulting from Bodily Injury or Property Damage.”  Bodily Injury almost always includes “emotional distress and/or mental anguish” within its definition found in the policy.  This type of exclusion is broad in scope and contains several avenues by which a claim for negligence can be denied by your E&O carrier.  The following phrases are key in reviewing the BI/PD exclusion in your policy:

EXCLUSIONS:”arising out of”
“attributable to”
“directly or indirectly resulting from”

Suits against insurance agents and brokers, often contain allegations of failing to provide adequate coverage.  Such allegations arise when GL or property claims of their clients are denied by an insurance carrier.  These suits often allege bodily injury, property damage or mental anguish as a result of your placement of the wrong or inadequate coverage.  Depending on the particular details and circumstances, the suit for failing to place adequate coverage will often be covered by a standard E&O policy.  However, allegations of bodily injury, mental anguish or emotional distress can often times be left uncovered because of the type of language found in your policy’s BI/PD exclusion.  When an allegation is deemed “not covered,” your E&O insurer is not obligated to provide any further defense.  This could leave an insurance agent or broker vulnerable not only for the cost of settling that part of the claim with the claimant, but also to paying attorney’s fees and other expenses.  Even in a ‘minor’ claim, this could cost an insurance agency thousands of dollars.

What can you do?

To help mitigate against this type of uncovered claim we have been successful in getting many E&O carries to provide a  professional services “add- back.”  This will not pay for the bodily injury claim, but can provide coverage for the  agency/brokerage for providing or failing to provide a Professional Service as defined in the policy.

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