Warren Buffett, often ahead of the curve, sounded like a disrupter in a 2004 shareholder letter. Fifteen years ago, Buffett wrote, “Insurers have generally earned poor returns for a single reason: They sell a commodity-like product. Policy forms are standard, and the product is available from many suppliers, some of whom are mutual companies (‘owned’ by their policyholders rather than stockholders) with profit goals that are limited. Moreover, most insureds don’t care from whom they buy. Customers by the millions say, ‘I need some Gillette blades’ or ‘I’ll have a Coke,’ but we wait in vain for ‘I’d like a National Indemnity policy, please.’ Consequently, price competition in insurance is usually fierce.”
Although his statements contain fundamental flaws, Buffett thinks he has found the answer to the perceived problem and has joined the “Disrupter League” (yes, this is a made-up term). Berkshire Hathaway recently announced the launch of THREE, a dangerous attempt to simplify multiple insurance contracts for small business owners.
Buffett introduced THREE stating, “Insurance is important protection for any business, but few small businesses have the time to actually read through the policy forms that are supposed to protect them. With THREE a small business can be confident in the protection it is getting, because the whole policy can be read in a few moments. Every day, America’s small businesses prove that great things come in small packages. Now they can get insurance on the same basis.”
THREE, as its name foreshadows, is a three-page small-business policy Berkshire Hathaway insists is easy to read, understand and apply. Buffett’s intent is to replace multiple policies and endorsements with one, three-page policy. The seven coverages included in this policy are:
- Property coverage;
- General liability coverage;
- Auto coverage;
- Errors and omissions coverage;
- Directors and officers liability coverage;
- Cyber coverage; and
- Workers’ compensation coverage.
THREE’s “easy-to-read” policy language can be found here for your review. Let’s see if Buffett’s team met the insured’s needs.
Gaps and Problems
Combining and condensing functionally and factually dissimilar coverages inevitably leads to gaps and other unanswered problems. THREE proves this. This is a policy with holes and problems. How bad is it? Let’s take a look at a few of the key issues.
Property coverage holes, gaps and issues:
- Business property. The policy extends protection to “property your business owns or leases” – that’s it. While that sounds great, this grant of coverage doesn’t address other property normally covered by the BOP such as:
- Property of others;
- Tenants improvements and betterments (they are not owned by the insured or leased, see this article for details);
- Animals owned by others and boarded by the insured; and
- Exterior building glass the insured is required to cover by the lease;
- Ordinance or law. Although limited to increased cost of construction in the BOP, ordinance or law coverage can be added by endorsement. The three-pager excludes ordinance or law coverage and offers no endorsements to add the coverage back;
- Business income limitation. The BOP provides “actual loss sustained” for up to 12 months without a specified limit (there are still problems here, but that’s a different discussion). According to the three-page policy, there is an applicable limit “on the Summary;”
- Business income does not appear to cover the payroll of anyone who is an officer, executive, department manager, or an employee under contract. Re-read their definition of “Net Income” if you don’t believe me and give me a different interpretation;
- Extended business income is not addressed. Maybe that’s what the policy means by “normal operations,” but it’s not specified. THREE seems to have mixed definitions, thus coverage is not clear and probably not there;
- Business Income – Dependent Property Coverage. There is no dependent property coverage at all. Although limited in the BOP, it can be increased as needed;
- Debris removal is not addressed. Again, the three-pager says it will pay for damage to the building and personal property, but it doesn’t say if it will pay to remove the debris of the damage building/personal property;
- Extra expense in the three-pager is subject to the business income limit found in the previously-referenced “Summary.” This is not the case in the BOP where extra expense is not subject to a limit, only a 12 month period;
- Pollution is fully excluded by Buffett’s policy. The BOP gives coverage for damage caused by pollution released by a “specified cause of loss.” The BOP also gives coverage for pollution extraction in certain circumstances;
- Newly acquired buildings. The BOP extends coverage to newly acquired buildings. Buffett’s policy only covers listed buildings;
- Valuation. It is not clear whether losses are settled on a replacement cost or actual cash value basis. The policy says it will pay to repair or replace, but it doesn’t say on what basis. Without specificity, I can argue either side; and
- Other property coverages in the BOP not found in Buffett’s policy include: Civil Authority, Money Orders and Counterfeit Money, Forgery or Alternation, Fire Extinguisher Systems Recharge, Personal Effects, and various other traditionally covered property.
Liability coverages included in this form are general, professional liability and directors and officers liability. Buffett has created a few gaps in his attempt to disrupt and/or simplify these “standard” forms:
- Defense. Is defense within or outside the coverage limits? The three-page policy does not specifically say. Although the policy states, “We will provide legal counsel to defend such claims;” it does not say if such cost is in addition to the policy limits or a part of the policy limits. Lack of clarity creates its own issues;
- Deductible. The three-pager states that there is a liability deductible and that the company will pay the loss and bill the insured for the deductible once the loss is settled;
- Pollution. The pollution exclusion in THREE’s policy is truly absolute. The BOP’s pollution exclusion mirrors the CGL’s and is not absolute. In fact, there are several express and implied exceptions to the pollution exclusion in the BOP and CGL;
- Contractually assumed liability is completely excluded in Buffett’s policy. ISO’s BOP has an “insured contract” exception as does the CGL. Such exception is definitely needed for any insured who signs a lease or any other contract;
- Additional insureds. Wording in the THREE policy does not provide ANY coverage on the general liability side the additional insured expects or needs. In essence, naming an additional insured extends little to no protection (even less than that extended by the BOP or CGL). The policy reads: “When listed Additional Insureds or employees of your business act on its behalf, they are also covered.” At what point does an additional insured ever act on behalf of the named insured? Generally, the named insured is acting on behalf of and for the benefit of the additional insured. Essentially, AIs that are held vicariously (or even jointly) liable for the actions of the named insured are not protected which violates the purpose of being an AI;
- Insured status. Beyond the named insured, the only persons/entities covered in THREE’s policy are employees and named additional insureds (to the extent mentioned above). The BOP and the CGL have a list of who qualifies as an insured. Who is an insured varies based on entity type; also, there are other automatic insureds beyond just employees. Buffett’s policy leaves a large number of people (and entities) uninsured;
- No personal and advertising injury coverage. The policy covers an occurrence which is defined as an accident, including continuous or repeated exposure to substantially the same general harmful conditions. Every act defined within the BOP’s and CGL’s meaning of personal and advertising injury is an intentional act and does not fall under the meaning of an occurrence;
- Medical payment coverage is missing; and
- Directors and officers issues:
- Is the business covered or just the employees individually? The policy says it will cover claims against directors and officers. Is it indemnification or on behalf of?
- Coverage does not appear to be full prior acts coverage due to this wording, the very first line in the policy, “This policy only covers your business for loss caused by occurrences during the policy period.” Further, there is no method for purchasing “nose” or tail coverage.
- The definition of “occurrence” does not pick up wrongful acts – which is what is generally covered by D&O policies. Review the very first paragraph of the policy.
- No “consent to settle” clause. The insured has no say in whether a D&O claim is settled. The policy states, “For liability claims, we will have the right to decide how to prepare for and defend any potential claim, and to decide if a claim should be settled.” (This same issue applies to the E&O coverage.)
At least 27 holes, gaps and issues are present in just these two coverage grants; but we aren’t done analyzing the policy just yet. Let’s turn now to the auto coverage.
- Protection for autos is limited to specified autos only. If the vehicle is not listed in the “Summary,” it’s not covered. There does not appear to be an option that is equal to ISO’s Symbol 1 – Any Auto. What’s worse, the insured doesn’t even get the 30-day automatic coverage found in Symbol 7. The auto must be listed to be covered;
- No hired and non-owned liability coverage is available. Again, it only covers listed autos and there is no wording to extend coverage for autos owned by others driven on the insured’s behalf. Even though the insured is covered under the other person’s or entity’s policy, it doesn’t have any excess protection if the other party’s limits are insufficient;
- Uninsured and underinsured motorist coverage is not addressed. I guess this wording could extend such protection when required by law, “Should any part of this policy, on its effective date, conflict with the laws of the state where your business is based, then that part of this policy will be automatically amended to meet the minimum requirements of those laws.” I guess any insured in a state that does not require UM and/or UIM protection does not have the option for such coverage;
- Insured status is unclear. ISO’s BAP extends protection to anyone using a covered auto. THREE extends insured status to the named insured and employees only (ignoring AIs at the moment). What if someone other than an employee is driving a business-owned vehicle? I guess they aren’t protected;
- The lack of necessary endorsements. When an insured purchases or leases a vehicle often they must attach specific endorsements to extend protection and/or rights to certain entities such as the loss payee or the lessor. This is not an option in THREE’s policy; and
- Drive Other Car coverage is not an option.
Like the liability section, the business auto cover is also subject to problems or questions surrounding defense coverage, deductibles, and the lack of medical payments coverage. Generally, auto liability coverage is NOT subject to a deductible, but that does not appear to be the case in this policy. Likewise, medical payments, a staple of business auto policies, is not covered in this section.
THREE’s workers’ compensation protection is quite fascinating. What NCCI takes six pages to expound upon, THREE covers in one paragraph. Do you think it’s possible something might get missed – by THREE? Let’s explore.
- Extraterritoriality and reciprocity. This may be an area where Buffett has done better than the system. NCCI’s policy extends coverage to employees only in listed states. This policy does not require a state be listed for coverage to apply. But I doubt the underwriters or actuaries understand the liability they have taken on with this overly broad coverage grant; and
- Employers’ liability coverage is not expressly provided in THREE’s coverage. Employers’ liability is a major gap filler between workers’ compensation and coverage provided by the CGL. However, there is no exclusion in the liability coverage for employee-based injuries as is found in the CGL. So, the lack of an exclusion may extend employers’ liability protection – whether intended or not; and
- Fellow employee coverage. Unlike most other property and casualty contracts, NCCI’s policy extends protection to only one party – the named insured. There is no list of who qualifies as an insured because the only party subject to the workers’ compensation law is the employer; again, the named insured. If an employee sues another employee for an injury (which is allowed in some states), the work comp policy does not respond. Likewise, ISO’s general liability policy specifically excludes from coverage any cause arising out of an injury to an employee (other than a third-party-over contractual exception). So, even though an employee is an insured in the CGL, he/she is not protected for suit by a fellow employee. However, Buffett’s policy states that both the employer and employees are insureds in the policy irrespective of coverage part. Further, there is no exception or exclusion for co-employee suits in this section, so there is coverage.
In a strange twist of fate, THREE’s policy may be the best option for the workers’ compensation exposure – if allowed in a state. But even with these potentially beneficial features, there are many “employment” relationships that may or may not be adequately addressed by this policy such as subcontracted labor, a PEO arrangement, employees hired from a temp agency, de facto employees or borrowed servants. Workers’ compensation is far more complicated than is expressed by this one paragraph.
Granted, as mentioned previously, Buffett’s form does offer three rarely packaged coverages (cyber coverage, errors and omissions, and directors and officers), but even these coverage grants lack specificity. A lack of specificity generally results in court dates to decide how the coverage responds. There isn’t even enough in these policies to be considered ambiguous.
Beyond the issues laid out in this expose, there are many “little” problems not addressed. These “little” issues combine with the bigger issues already explored to ultimately result in major problems. Synergistically, this is a dangerous product.
Beyond the overt issues and gaps addressed, the greatest “unseen” problem with this policy is the inability to customize it to meet the insured’s needs.
All insurance policies, including this one, are written for the “average” insured; the problem is, there is no such thing as an average insured. Endorsements exist to allow the insured to customize a policy to meet its unique exposures. Without the ability to customize, the insured is stuck with an inadequate option – especially if this policy is the chosen option.
One last consideration. “Standard” insurance policies, those intended to be replaced by this three-page wonder policy, contain many definitions, limitations and exclusions not listed in this policy (coverage territory, coinsurance requirements, flood and earthquake exclusions, a liquor liability exclusion, an “other insurance” clause, etc.). The question is, do the actuaries really understand what they have? If or since there is no apparent sense of reality, the actuaries have likely underpriced this protection. If, however, they do know what they have given the world and have adequately priced for it, the premiums would be so high no one would purchase it.
The only explanation for giving away exceptionally broader coverage, risking the court costs associated with ambiguities surrounding exclusions, or not address key issues is the apparent lack of concern over the ultimate costs. With large amounts of capital, sound underwriting, reasonable coverage grants and actuarially sound pricing are unnecessary. But Buffett has amazing amounts of money to invest in new offerings and absorb unexpected losses. According to a recent Reuter’s report, Berkshire Hathaway has nearly $104 billion in cash and is in the process of negotiating the sell of Applied Underwriters (which will give them more cash).
For someone who believes insurance is nothing but a commodity and that the insurance industry is full of “also rans,” Buffett is pushing a “commodity” that doesn’t even live up to industry standards. THREE’s policy does not even qualify as an “also ran.” Buffett’s team has failed to produce a product that provides the “confidence” small business owners need. Further, the E&O nightmare agents could face from offering such a policy is unimaginable. Simpler does not mean better for any party involved in this policy.
Undoubtedly, some will take the bait and will not find the hooks in this policy until it’s too late. Shiny objects wrapped in technology, especially one cast into the waters by a respected name, will ultimately harm a lot of unsuspecting insureds. My hope is Buffett doesn’t personally know what is lacking in this attempt.
As I completed this piece, a conspiracy theory filled my mind. Maybe Buffett is waiting for the industry to respond and point out all the problems so they can be fixed (using the industry’s collective knowledge). But I don’t know, that’s sort of like believing Coke launched New Coke to increase demand for Classic Coke so they could ultimately win the “Cola Wars.” Coke execs always said they were neither that smart nor that stupid.
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