Viewpoint: Mirror Tests and Absolute Exclusions

Independent insurance agents are facing considerable and relatively new errors and omissions (E&O) exposures, as well as growing exposures from long-time variables. When speaking to audiences, I’ve found a large proportion of agency executives and personnel are unaware of these increasing exposures.

The hard market is exacerbating the situation. Hard markets cause a significantly higher percentage of policies to be moved from carrier A to carrier B at any given renewal. The E&O standard of care most applicable in this situation (standards vary by state and the following is fact specific, so do not consider this legal advice) is the Mirror Test.

The Mirror Test is used to check whether the new policy with the new carrier mirrors the expiring policy. If not, it is the agent’s responsibility to advise the insured of the coverages that are different, especially the coverages lost. I’ll repeat this: IT IS THE AGENT’S RESPONSIBILITY to notify, preferably in writing, of the coverages that are different and/or lost.

The case law on this subject is extensive, longstanding, and well-established. It does not matter if the policies are with admitted or surplus lines. It is the agent’s responsibility.

With surplus lines carriers, the Mirror Test also applies to renewals even if the policy renews with the same carrier. In surplus lines, no one generally must notify the insured of reductions in coverage at renewal–EXCEPT the retail agent. I know many retail agents rely on their broker or, in some cases, even their carrier to advise them if coverage is being reduced. That kind of relationship benefits the agent, but agents should never depend on that notification because no one has any legal responsibility to tell you they are reducing coverage.

The Mirror Test is arguably an impossible test to pass with a score of 100%, maybe not even 90%. Policy comparison is too complex and too time-consuming to be perfect, especially given today’s workloads. At the least, agencies need to be able to demonstrate they made a good faith effort, even if they are not perfect.

Absolute Exclusions

One, unfortunately, great example of why this is so difficult involves what are known as “absolute exclusions.” These exclusions are challenging to identify and understand. The use of absolute exclusions by carriers varies significantly, making it difficult to compare one form to another. Furthermore, these exclusions border, if not cross, the line of what might be considered unethical. The vast majority of people I know in this industry are not searching for policy language that contains unethical clauses. This makes it less likely they’ll find these exclusions.

In general, absolute exclusions are defense coverage exclusions. An example might be a financial auditor hired to investigate a company’s accounting. At some point during or following their work, the company experiences a cyber event, and all the company’s vendors are sued.

As a vendor, the financial auditor is sued for failing to identify the company’s cyber weaknesses. This is a ridiculous suit, but the auditor must still respond to it. When they respond, they notify their insurance carrier. The carrier denies any coverage. After all, the auditor had nothing to do with cyber, so there is no liability and no claim. But the auditor needs legal defense. The absolute exclusion, however, states that because cyber auditing is not one of the financial auditor’s professions, they have no defense coverage.

In other words, the auditor only has defense coverage for the specific professional services provided and nothing else. That “nothing else” is one big gap.

I recently read another case involving pollution. A dry cleaner was in a strip mall. A pollution claim was filed against the cleaners, and evidently, they did not have sufficient coverage to satisfy the plaintiffs. The plaintiffs then sued all the other stores in the strip mall and the strip mall owner for causing the dry cleaner to pollute. When a neighboring store filed a claim, the carrier denied it. There was no pollution coverage since the insured did not have any business activities that would pollute anything. The insured did not need actual pollution coverage, but they required defense coverage for allegations of pollution.

These are relatively simple examples in terms of absolute exclusions. Absolute exclusions are significant in agency E&O policies. The number of such exclusions varies between maybe zero and 14, according to Fred Fisher (and for everyone who wants to know more about absolute exclusions, read his deep analysis in the white papers he published at IRMI and/or listen to his presentations at www.ijacademy.com on Insurance Journal’s Academy of Insurance). Some of these absolute exclusions are more complex.

One popular agent’s E&O policy has an absolute exclusion for criminal acts. At first, this looks innocent. After all, what policy provides coverage for criminal acts (other than some extremely well-written cyber policies that recognized the idiocy of how cybercrime laws have been written)? The form states that coverage is excluded for criminal acts “based upon, arising out of, or in any way related to, directly or indirectly, any willful or criminal violation of any statute, rule, or law.”

The problem from the agent’s perspective is this: The exclusion is not limited to the agent’s acts. For example, if an agent’s client has a claim for a criminal act and the agent did not offer the client such coverage, resulting in an E&O claim against the agent, the agent would likely NOT be covered.

In other words, the absolute exclusion is not because the agent committed a crime but potentially because a client committed a crime, or even when the clients’ own customer is the perpetrator!

Additionally, as a side note, violating a rule is not always a true criminal act; therefore, this is an overly broad exclusion.

In these more complex situations, which often exist with the ERISA, Securities, Employment Practices, and various cyber exclusions, the issue is often where the agent could have sold the insured a policy that covered their actions but didn’t.

Instead, the agent failed to secure such coverage, which would then result in an E&O claim. In these cases, the agent wouldn’t have any coverage because their insured’s underlying actions are effectively excluded. The only protection for agents is to sell the client the coverage they need, so they do not incur an E&O claim.

Carriers seem to be inserting more and more exclusions that are difficult to notice, let alone explain, making the importance of the Mirror Test grow even more critical. The most common absolute exclusions can be found in professional liability and cyber forms, but they may also be creeping into other forms. These are extremely important exclusions to identify, address, and discuss with clients when moving from one form to another.