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0106 HR Magazine: Under the Radar: EPL Insurance

Eric Krell  1/1/2006
 

HR Magazine, January 2006Vol. 51, No. 1

Many HR professionals dont play a prominent enough role in managing their EPL insurance. Heres why they should.

Employment practices liability (EPL) is a hot topic these days. Discrimination, harassment and wrongful termination claims are attracting the attention of more displeased employees, plaintiffs’ lawyers and juries than ever before.

One in four privately held companies has been sued by a current or former employee in recent years, according to a survey by Chubb Group of Insurance Companies in Warren, N.J.

Despite these trends, EPL insurance—which helps cover the expenses of fighting such claims—often flies under HR’s radar, and many human resource executives aren’t playing a prominent enough role in purchasing insurance coverage. Instead, HR managers often leave too many insurance-related duties to the risk-management or corporate finance functions, which usually purchase EPL coverage.

Poor communications between HR and these functions often results in substandard EPL insurance policies, weaker EPL risk-management processes, higher-than-necessary premium prices and greater legal vulnerability.

According to Beth Schroeder, an employment law attorney with Silver & Freedman in Los Angeles, limited communications between HR and risk management or finance about EPL insurance can lead to such problems as:

  • Not buying EPL insurance at all.
  • Purchasing the wrong coverage.
  • HR professionals being unaware of free risk-management services the policy may provide.
  • Employers failing to inform insurers, or not properly informing them, when an EPL claim occurs.
“There are all sorts of unpleasant issues that can crop up when you leave HR out of the EPL loop,” says Schroeder. 

More Suits, More Legal Costs

One increasingly expensive trend that should be prompting HR professionals to better and more actively manage EPL coverage is the rise in employment law class actions. “Probably the biggest change in general during the past three years has been the increase in the amount of class-action filings,” says Mike Maloney, a senior vice president and worldwide project manager for EPL insurance with Chubb Group.

That increase has boosted EPL insurance premiums. “The frequency of claims continues to be costly for underwriters,” reports Richard Betterley, president of Betterley Risk Consultants Inc. in Sterling, Mass., and publisher of the only annual EPL insurance market survey. “Insurers have more covered claims than expected, combined with increasing defense costs. This has increasingly been met by some carriers with mandatory higher deductibles,” he says.

Surprisingly, the surge in class actions is most problematic for smaller companies—not the deep-pocketed mega-corporations one usually reads about in such suits.

“We see companies with a couple thousand employees that have been hit with multiple-claimant or class-action lawsuits,” says Maloney. “We’ve even seen divisions of large companies get hit. Instead of mega-cases that go for $50 million to $150 million, these are cases that might cost a couple million dollars to defend; if there is a resolution, it is in the $5 million to $20 million range.”

In addition to an increase in class actions in general, employers are likely to see more class actions based on age discrimination. Last year’s ruling by the Supreme Court in Smith v. City of Jackson opened the door to “disparate impact” claims under the federal Age Discrimination in Employment Act (ADEA), making it much easier for employees to file a class action.

In the case, a group of older Jackson police officers filed suit under the ADEA, alleging that the city’s new compensation plan created a “disparate impact”—a disproportionately negative effect on older officers.

However, the Supreme Court also ruled against the older police officers in a summary judgment, showing that employers can defend against disparate impact ADEA claims by demonstrating that their actions were based on legitimate business decisions.

As a result of the Smith ruling, Maloney says his company expects to see more age discrimination lawsuits. “Given the current prevalence of downsizing, outsourcing and layoffs … we expect to see more older workers take their shots,” he notes. “They will allege, ‘I lost my job or did not get an opportunity because of my age.’ ”

But Maloney says his company also expects to win many of those suits. “The employers are going to be able to step forward and say, ‘Well, here’s the real reason we made this decision; it had nothing to do with age.’ And that will be a sound defense.” Still, employers and insurers are likely to incur additional costs defending these age discrimination claims, even if they ultimately win. To that less-than-inspiring news, add the following fact: Between 1997 and 2003, the median jury award for employment practices liability claims in the United States rose nearly 100 percent, to $250,000.

Cutting Premiums with SOX

Another legal trend with implications for EPL insurance is the far-reaching Sarbanes-Oxley Act (SOX), with its emphasis on internal controls and corporate governance. The law has shed more light on HR processes that can help mitigate EPL risks—and possibly lower EPL insurance premiums at renewal.

Tom Hamms, managing director, national employment practices liability practice leader for Aon Corp., is a broker who helps corporate clients find EPL insurance policies that best match their needs. He believes SOX has inspired HR leaders to develop uniform employee handbooks in large companies that previously may have had five different handbooks in five different divisions. The new law, Hamms adds, also motivated many companies to rewrite their codes of conduct, which typically include core HR policies and procedures.

Those types of improvements may be looked on favorably by EPL insurance underwriters. “It’s difficult to quantify [SOX-related process improvements in HR] in terms of real changes that we see in our actual loss experience,” says Maloney. “Making those connections is not the easiest thing to do because it requires the proving of a negative: ‘We did X, so we didn’t have claims.’ I do believe that some companies see it that way and have improved. And, as an underwriter, I take that into account.”

But the key, once again, is that HR must communicate with finance, risk management or whichever function purchases EPL insurance. Otherwise, the work being done by HR to comply with SOX may never be passed on to the EPL provider, and the potential premium savings may never be realized.

Insurers as Service Providers

As employers work to improve their processes, they should look to their EPL providers for help. More underwriters are trying to strengthen their customers’ EPL risk-management practices by bundling free loss-prevention services with their insurance offerings. These services include web-based training sessions, other training from law firms and risk-management firms, employee handbook models, templates for policies and procedures, and employer hotlines.

Law firms administer these hotlines with lawyers answering employment law questions from supervisors, managers and HR executives—hopefully before they make a potential mistake. For example, a supervisor might use the hotline to get advice about the ramifications of firing a direct report who is on a leave of absence.

“One of the best ways to eliminate a bad lawsuit is to have somebody smart enough to make a phone call before they do something stupid,” says Schroeder, whose firm administers these sorts of hotlines for several companies. “We know that we save people from doing things that would have gotten them into trouble.”

How much do providers allocate for such risk-reducing efforts? At Chubb, qualified customers can receive an amount equivalent to 10 percent of their annual premium to spend on bolstering their EPL risk-management capabilities. For large companies, that can translate to $30,000 or $40,000 worth of services.

EPL insurance carriers offer the loss-prevention services gratis in the hopes of generating more loyal customers and reducing losses.

“Sure, we think there’s going to be a benefit in terms of fewer losses, which would ideally make the product more profitable,” says Maloney. “But the more profitable the product is, the more attractive we can be with our pricing.”

There’s only one problem with that model: Companies are not taking advantage of these free services, despite their pricing and prevention benefits.

“We see very few actual users of these services,” says Maloney, who notes that only about 10 percent of all companies who qualify for loss-prevention services from EPL insurance providers actually make use of the benefit.

“These services are readily available but are not communicated to the HR people,” notes Betterley. “I’ve worked with clients that are spending money on services and I say, ‘Do you know you can get this from the insurance company?’ The initial reaction tends to be that the services can’t be good because they’re free.”

But in several cases, says Betterley, clients chose the same provider and paid for the exact same services they could have gotten at no cost through the EPL insurer.

A Costly Communication Breakdown

As Betterley suggests, the communication breakdown between HR and the purchasers of EPL insurance coverage, usually risk management or finance, can be costly. Yet, it’s difficult to get a read on the problem from HR executives, who appear averse to publicly discussing their company’s EPL insurance and their role in maintaining it.

“EPL insurance is generally handled by finance departments as part of their insurance-purchasing programs, often bundled as part of D&O [directors’ and officers’] insurance,” one HR vice president explained in an e-mail in response to an interview request. “It is not generally on the HR radar screen.”

It should be.

“Communication is a critical element in this process,” notes Kevin Shaughnessy, a partner in the Orlando, Fla., office of the law firm Baker & Hostetler. “The communication involves general counsel, risk management, the insurance company and HR. HR ought to be involved in that process because HR can help save money by gathering all of the right information” for the underwriter.

Maloney, for one, is attracted to potential EPL customers who make the top human resource executive and/or the HR professional in charge of the organization’s diversity program available to speak to him when the company is shopping for EPL insurance.

“I probably provide the best terms to customers who have demonstrated their awareness of all of the loss-prevention steps they are taking,” he adds. “Even when they identify negatives—‘We have a gap here, but here’s what we’re doing to fix it’—I view that in a positive light. I’d rather provide coverage to somebody who knows where they have deficiencies and is trying to attack them, than to the employer who has their head in the sand and assumes that because it hasn’t happened before, it won’t happen now.”  Graph One

Negotiating with a Carrier

Human resource managers have two primary responsibilities involving EPL. First, they should ensure that the underwriter—directly, via risk management or through a broker—is fully and accurately informed of all the HR processes and systems in place that help reduce the risk of EPL lawsuits. Those activities include but are not limited to:

  • Sound anti-harassment policies and procedures.
  • Anti-harassment and inclusiveness training.
  • An open-door policy.
  • Regular audits of EPL-related policies and procedures.
  • Training customized to supervisors and managers who are responsible for reporting and elevating claims.
  • Employee handbook sign-offs.
  • Diversity-related mentoring programs.
  • Formal processes for handling charges and complaints filed with the Equal Employment Opportunity Commission.

Second, HR managers should ensure that the company is prepared to handle potential litigation. Much of that preparation depends on the policy and the company’s relationship with the EPL insurance carrier. HR professionals can strengthen their organization’s negotiating hands during sessions with EPL insurance carriers through the following steps:

Understand the coverage. One of the most common forms of EPL litigation is wage and hour cases (claims involving the classification of nonexempt employees as exempt, or the failure to pay overtime)—which are not covered under any EPL insurance policies at this time. However, plaintiffs’ attorneys tend to sue on more than one count. If one of those counts—wrongful termination, for example—is covered by the policy, the insurance company is obligated to cover the cost of defending (but not settling or paying damages on) all of the counts brought in the suit.

Understand special coverages. In many states, EPL insurance carriers are prevented from paying a claim, even when a policy states that the carrier must cover the claim, due to state law. For example, some states restrict or prohibit coverage of punitive damages—for the same reason motorists can’t buy insurance coverage to protect them from a speeding ticket, Betterley explains. “The idea in these states is that punitive damages are supposed to serve as punishment,” he adds.

Some states also prohibit or restrict insurance coverage for actions deemed to be “intentional acts.” At least 15 states, including New York and California, prohibit or restrict insurance coverage for punitive damages or intentional acts.

However, many EPL insurance carriers offer special coverage in those states. One way around a state statute preventing the reimbursement of punitive damages, for example, is for the carrier to include language in the policy that refers to a “most favorable venue.” If the claim occurs in a state where the carrier cannot pay punitive damages but the insured company’s headquarters is located in a state without that restriction, it agrees to pay the punitive damages.

Influence the selection of external counsel. Many carriers specify which attorneys or law firms (called “panel counsel”) will be used as external legal counsel if and when a lawsuit occurs. Some carriers, Shaughnessy notes, allow customers to select an “accommodation counsel”—in other words, choose their own attorneys. That selection process should be discussed and agreed to before the policy is purchased.

Agree on a litigation philosophy. There may be cases that a company does or does not want to settle quickly. A company may want to settle immediately to ensure that an upcoming merger proceeds as planned—or, simply because the company has an extremely high profile and wants to avoid damaging its brand.

Shaughnessy says his more sophisticated corporate clients take a fairly standard approach to litigation: They want external counsel to go in quickly, review all of the documents, take a quick deposition of plaintiffs and assess whether the case is ripe for summary judgment. If the case does not look like it will be thrown out before a trial, settlement discussions immediately commence.

“You can settle cheaper now than you can settle after a year’s worth of discovery,” says Shaughnessy. “That early assessment of the risk is probably the best approach to litigation. Most employers probably have that philosophy. They should make sure that the carrier does, too.”

Lower Your Radar

Contrary to what some HR executives believe, EPL should figure prominently on their radar screens. Even if HR does not purchase EPL insurance, it can work closely with the purchaser, general counsel and the insurance carrier to ensure that the policy is a good fit at a good price. Doing so requires work, but it should come naturally. When attorney Schroeder first became involved in EPL insurance 11 years ago, she was approached by someone who was eager to launch a risk-management practice that focused exclusively on EPL.

“He told me that nobody has ever done risk management for EPL,” Schroeder recalls. “I looked at him and said, ‘What do you think HR does?’ The things that insurance companies call risk management or loss prevention are the prophylactic measures human resource people have been putting into place as long as the function’s existence.”

Eric Krell is a business writer based in Austin, Texas, who covers  HR and finance issues.

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