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Owner Controlled Insurance Program Liability Claims Challenges, Part 5

The first issue that the carrier and the policyholders must address is whether the loss resulted in "covered damage.” However, with an Owner Controlled Insurance Program, the analysis with regard to the particular insured is critical. There are numerous exclusions in the commercial general liability coverage form that apply differently, depending on whether the named insured enrolled contractor is an owner, general contractor, or subcontractor.|

Harry Griffith

September 26, 2011

This is the fifth article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 2, Part 3, Part 4, Part 6, Part 7, Part 8, Part 9, Part 10, and Part 11. Owner Controlled Insurance Programs From The Perspective Of Liability Claims (continued) Covered Damage The first issue that the carrier and the policyholders must address is whether the loss resulted in "covered damage.” However, with an Owner Controlled Insurance Program, the analysis with regard to the particular insured is critical. There are numerous exclusions in the commercial general liability coverage form that apply differently, depending on whether the named insured enrolled contractor is an owner, general contractor, or subcontractor. The following exclusions illustrate why the policy may provide coverage or not, depending on which insured is seeking coverage: Expected or Intended Injury Exclusion

This insurance does not apply to: a) Expected or Intended Injury "Bodily injury” or "property damage” expected or intended from the standpoint of the insured ...

Use of the phrase "the insured” refers to the insured seeking coverage. This phrase is contrasted to an exclusion that applies to an injury which is expected or intended from the standpoint of "an” or "any” insured, which would preclude coverage entirely under the policy if an insured or any insured intended the act. (See, e.g., National Union Fire Insurance Company vs. Lynette C. (1991) 228 Cal.App.3d 1073 — a wife who negligently failed to prevent molestation by her husband was covered; Fire Insurance Exchange vs. Altieri (1991) 235 Cal.App.3d 1352 — parents sued in connection with their son's arson of a school building.) The phrase "the insured” also is contrasted to exclusions that apply to "you,” which is the named insured. In the context of an Owner Controlled Insurance Program, where virtually every contractor is an insured, particular attention has to be paid to whether the claims of "supervision,” "vicarious liability,” or other non-direct liability could create coverage where the exclusions apply to "the insured.” For example, in a claim that a contractor's employee intentionally damaged another contractor's work, the employee would be an insured, but the exclusion would bar coverage. His employer, assuming it was enrolled, would likely be a named insured; the exclusion would not apply to the employer, or any other enrolled contractor on the project. Contractual Liability Exclusion A second example is the contractual liability exclusion, which provides:

This insurance does not apply to: ... b) Contractual Liability "Bodily injury” or "property damage” for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages: ... (2) Assumed in a contract or agreement that is an "insured contract” ...

The typical construction project contains indemnity flowing uphill in favor of the owner and general contractor. The liability of the owner or general contractor is generally passed down to the lowest level subcontractor. Under contractual liability coverage, the Owner Controlled Insurance Program assumes every enrolled contractor's indemnity obligations upward to the general contractor and owner. Contractual liability coverage allows owners/sponsors to settle claims with third parties and seek recovery from responsible subcontractors under the indemnity agreement. Thus, the insurance company must be mindful that any enrolled contractor may be both an insured as well as a claimant against the downhill subcontractors for any uncovered damages. Damage to Project Work The next series of exclusions are those dealing with damage to the work which is the subject of the Owner Controlled Insurance Program:

This insurance does not apply to: ... j. Damage to Property "Property Damage” 1) Property you own, rent or occupy; … 4) Personal property in the care, custody or control of the insured; 5) That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf or performing operations, if the "property damage” arises out of those operations; or 6) That particular part of any property that must be restored, repaired or replaced because "your work” was incorrectly performed on it. Paragraph 6 of this exclusion does not apply to "property damage” included in the "Products-Completed Operations Hazard.” k. Damage to Your Product "Property Damage” to "your product” arising out of it or any part of it. l. Damage to Your Work "Property Damage” to "your work” arising out of it or any part of it, and included in the "Products-Completed Operations Hazard.” This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.¹

With regard to property damage claims arising out of "operations” (as distinct from "completed operations”), Exclusion "j.” is critical. In light of the "separation of insureds” condition, Exclusion j(1) would exclude coverage to the program sponsor for damages occurring to the construction project itself. (Assuming the sponsor is the owner.) Exclusions j(5) and j(6) preclude coverage for damage to the construction project, but not entirely. Viewing the construction project from the standpoint of a general contractor, the entire project is "real property” on which the named insured (defined alternatively as "you”) or its subcontractors are performing operations. As to the owner or general contractor, virtually any damage would be excluded if it is within the basic scope of the construction project and the project is not completed. However, each enrolled contractor must be viewed separately. If there is an allegation of damage caused by a subcontractor to work other than its own, this exclusion would not bar coverage. An example would be a residential developer with an Owner Controlled Insurance Program covering its projects that experiences a fire at a home under construction caused by the negligence of the roofer. As to the owner/developer, exclusion j. precludes coverage entirely. As to the roofer, exclusion j. only precludes coverage for damage to the roofer's own work, but not resulting property damage caused by the roofer, i.e., the burned down home. This scenario constitutes the primary overlap with builders risk coverage. The owner/ general contractor may pursue a subcontractor for negligence arising out of performance of work under its contract, and the subcontractor's liability will be covered by the Owner Controlled Insurance Program. This gap presents an exposure to the liability Owner Controlled Insurance Program insurer for the builders risk deductible (since the amount is not covered by builders risk insurance). This scenario also illustrates that for owners or insurance companies, the proper analysis is to review any "operations” loss — those that occur while the project is under construction — first from the perspective of the responsible contractor (from the bottom up) rather than from the perspective of the owner (from the top down). ¹ The terms "you" and "your" refer to the named insured, not to anyone qualifying as an insured.

Harry Griffith

The late Harry Griffith had over 25 years of experience in insurance coverage, trial and appellate work. He was a partner of Branson, Brinkop, Griffith & Strong, LLP, and supervised the coverage group within the firm, which consisted of eight coverage attorneys. Mr. Griffith published numerous opinions in the area of insurance coverage. Mr. Griffith was a named California Super Lawyer both for 2009 and 2010.

Life & Health

Healthcare Reform and the Courts, Part 2

The Florida Court agreed with the states on both counts. Basically, the court said that the government cannot compel people to engage in an activity like buying health insurance. That authority is left to the states. And they agreed that this portion of the Patient Protection and Affordable Care Act was not severable and, therefore, the whole thing is unconstitutional.|

John Nelson

September 25, 2011

This is the second article in a 3-part series on Healthcare Reform and the Courts. Preceding and subsequent articles in this series can be found here: Part 1 and Part 3. How The Florida Court Ruled The Florida Court agreed with the states on both counts. Basically, the court said that the government cannot compel people to engage in an activity like buying health insurance. That authority is left to the states. And they agreed that this portion of the Patient Protection and Affordable Care Act was not severable and, therefore, the whole thing is unconstitutional. The court's rationale here was interesting, I thought. The reality is that Congress passes a lot of laws that do not include a severability clause. And yet many of those laws remain in place after the court has ruled against certain provisions of them because severability is implied. The courts, not wanting to thwart the will of the people via their elected representatives know that throwing out every single law because of problems with certain sections would create a logjam in government and nothing would get done. So the courts prefer not to do this. But judges don't automatically assume severability. They go back to and research any documentation they can get their hands on to determine whether or not lawmakers intended to include severability in the legislation. And that's just what the Florida judge did with the Patient Protection and Affordable Care Act. So what did he find? He found that a prior draft of the Patient Protection and Affordable Care Act did include a severability clause which meant that for some reason, someone pulled it out when the final version was reported out of Congress — possible evidence that Congress did not mean for the Patient Protection and Affordable Care Act to include severability. Additionally, the judge did more homework and then came across news clips of the President of the United States talking about the importance of the individual mandate and saying that without the mandate, everything else including the provisions that mandate carriers to provide guarantee issue coverage with no waiting period on preexisting conditions would collapse. We can't force carriers to do this unless everyone is covered, he said. Congress pulled the severability clause from a prior draft of the law and the President was publicly quoted as saying that without the mandate, other aspects of the law won't work. So the judge concluded that legislators felt that you couldn't have one without the other. And that's why the Florida judge cited in his reasoning that the ruling that the individual mandate is an overreach and, therefore, the whole thing must go down with it. With the judge ruling against the feds and striking down the Patient Protection and Affordable Care Act, the feds appealed to the District Court of Appeals. The District Court of Appeals Ruling Three judges were involved in the ruling of the district court — two Democrats and one Republican. Basically, one of the Democrats and a Republican agreed with the Florida judge on the mandate. And they carried the argument one step further. If the Patient Protection and Affordable Care Act's individual mandate is left to stand, then where do the feds stop? If a person's coverage status affects the financial health of the overall healthcare delivery system, then why not compel him to workout, eat better, etc, etc, etc? Not stopping the mandate opens the door for the federal government to impose all kinds of requirements on citizens that the government deems beneficial to overall society. Where does federal authority stop? Allowing the individual mandate to stand would be tantamount to opening a giant door for additional federal influence over states' rights. But the appeals court disagreed with the Florida judge over the severability clause. The court said that standard protocol within the House of Representatives assumes that most legislation is severable and that a specific clause isn't always necessary. The court was sensitive to the impact on the insurance industry if carriers are required to take all applicants with no waiting periods on preexisting conditions with a mandate. But the judges didn't think this was all that important given that most of the people the mandate would apply to already have coverage. Those who don't have coverage now, they said, are those who would be eligible for Medicaid and individual subsidies. So if the bulk of the population the mandate would apply to is already insured, then the mandate is not really that important (they did not address the scenario where people may opt to drop their coverage if they know they can get it anytime when they really need it). So now we have a bit of a disagreement between the Florida court and the appeals court — not to mention all the other Patient Protection and Affordable Care Act-related lawsuits that are being litigated in other courts throughout the county. Conflicting views and directives from a law as expansive as the Patient Protection and Affordable Care Act is not conducive to harmonious execution of the provisions of that law. Given the two different rulings, what is a given state to do? Do you follow through on the mandate or not? Do you begin building the exchanges or not? You have one court that says no and another that says kind of. It is for these reasons and many others that people believe the next stop is the Supreme Court.

John Nelson

John Nelson has long been a champion of legislative and educational efforts in the health insurance industry. He is a Chief Executive Officer of Warner Pacific Insurance Services, one of the nation’s largest health insurance general agencies serving over 35,000 small employers with over $1.5 billion of inforce premium.

Claims

Owner Controlled Insurance Program Liability Claims Challenges, Part 4

An Owner Controlled Insurance Program general liability policy is, in most respects, similar to the industry standard general liability policy. An Owner Controlled Insurance Program claim is analyzed by taking the same systematic approach that is used with other insurance claims. Companies and insureds alike should resist the temptation to treat the Owner Controlled Insurance Program differently and/or disregard the policy language. Only in taking consistent approaches will the insurance company make sure that the most appropriate legal and business decisions are made.|

Harry Griffith

September 25, 2011

This is the fourth article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 2, Part 3, Part 5, Part 6, Part 7, Part 8, Part 9, Part 10, and Part 11. Owner Controlled Insurance Programs From The Perspective Of Liability Claims An Owner Controlled Insurance Program general liability policy is, in most respects, similar to the industry standard general liability policy. An Owner Controlled Insurance Program claim is analyzed by taking the same systematic approach that is used with other insurance claims. Companies and insureds alike should resist the temptation to treat the Owner Controlled Insurance Program differently and/or disregard the policy language. Only in taking consistent approaches will the insurance company make sure that the most appropriate legal and business decisions are made. From a legal perspective, the insurance company will be questioned on its policy interpretation and claims handling. The insurer's obligation to the insured to defend and indemnify is measured by the policy as issued. Coverage under the policy is not based on side agreements, or understandings between the sponsor, the broker, and the underwriters. If there are unintended claims being paid, the underwriters need to be alerted and the policy language changed. An insurance company can waive reliance on a restrictive policy and provide greater benefits than the contract provides. Waller v. Fire Insurance Exchange (1995) 11 Cal.4th 1. However, the company may not unilaterally narrow the coverage and provide less than that provided by the policy. The exception to this rule is, of course, if there is proof that the policy as issued failed to comply with the mutual intent of the parties, in which case the policy may be reformed. (See, e.g., Cal. Civ. Code Sec. 3399; Truck v. Wilshire Insurance (1970) 8 Cal.App.3d 553.) The following are some of the highlights of the commercial general liability form that are particularly applicable to construction claims involving Owner Controlled Insurance Programs. Separation of Insureds A general liability policy contains a condition, titled "Separation of Insureds.” That provision provides:

Except with respect to the limits of insurance, and any rights and duties specifically assigned in this coverage part to the first Named Insured, this insurance applies: a) As if each Named Insured were the only Named Insured; and b) Separately to each Insured against whom claim is made or "suit” is brought.

In the typical Owner Controlled Insurance Program, each contractor and subcontractor qualifies as a "named insured.” The insurance company must view each named insured separately, as if that contract were the only contract to apply. Each named insured under the policy is given equal coverage. The carrier's duty to provide a defense and indemnity exists separate and distinct from every other contractor under the policy. Each named insured has an obligation to tender the loss to the insurer and must cooperate with the insurer in the investigation of the claim or suit, and in its own defense.

Harry Griffith

Life & Health

Healthcare Reform and the Courts, Part 1

The Patient Protection and Affordable Care Act is over 2,700 pages long and affects virtually every aspect of healthcare delivery and its related financing (the insurance component) including Medicare, Medicaid and private insurers.|

John Nelson

September 23, 2011

The decisions to date, the ones to come and their meaning to agents and our industry This is the first article in a 3-part series on Healthcare Reform and the Courts. Subsequent articles in this series can be found here: Part 2 and Part 3. A lot of agents have been wondering what the outcome will be with the legal challenges against the Patient Protection and Affordable Care Act. I will attempt to articulate what I think might happen. My discussion will be limited to certain aspects of the bill — primarily with regard to the individual mandate and the question over severability. So I will be excluding a fair amount. Remember, the Patient Protection and Affordable Care Act is over 2,700 pages long and affects virtually every aspect of healthcare delivery and its related financing (the insurance component) including Medicare, Medicaid and private insurers. It even deals with student loans. Also, my discussion will be limited primarily to one challenge to the law — the one that involved dozens of states suing the federal government in a Florida court. There are a number of other legal challenges against the federal government that might lead another observer to draw a different conclusion on how these challenges will ultimately pan out down the road. But given the clout and importance of the states, many observers including myself have been particularly interested in that one. Before I address what I think might happen with the Supreme Court, I think it is important to understand the status of the States' lawsuit and how they got here. So I will be first explaining why the states sued the federal government, how the court ruled and the subsequent action by a district appeals court. The Reason The States Sued The Feds The primary reason over two dozen states and other parties (the plaintiffs) sued the federal government is because of the individual mandate. They simply do not think that the federal government has the authority to mandate citizens to buy health insurance. The states believe that the decision about whether or not to compel someone to buy insurance is theirs to make and not the federal government's. By the way, this is why folks aren't challenging the likes of Massachusetts which has a similar mandate in place. Massachusetts has the authority as a state to do this. In more technical terms, the states believe that the federal government via the Patient Protection and Affordable Care Act is stretching what's known as the "Commerce Clause" beyond what it was designed to do and is an overreach of power by the federal government. It all harkens back to our history and the compromises that came together to form our nation. The federal government has powers but so do the states. The original 13 individual states wanted to retain a certain amount of autonomy when they formed the union. So there are powers unique to the federal government and there are powers unique to the states. The Commerce Clause was created about a hundred years ago and has evolved over time. It was created to address the question of which governmental entity has the power of regulating business when business is transacted across state lines. For example, let's say that California has the authority to regulate the California Widget Makers. Colorado has the authority to regulate the Colorado Widget Makers, too. But the way they regulate their Widget Makers is different than how California regulates its Widget Makers. The regulations are different and were promulgated out of the customs and needs of the unique populations. Let's now assume that Joe's California based widget company has decided to expand its customer base beyond California and into Colorado. Which regulations apply to Joe? Colorado's or California's? The Commerce Clause exists, in part, because it answers this question and creates consistency for the likes of Joe because he only has to play by one set of rules and not two. Back to the Patient Protection and Affordable Care Act. So the law mandates that people will have to buy individual coverage starting in 2014. The states are saying "no, whether or not they should be forced to buy coverage is our call, not yours." The feds are saying it's their call because a persons decision about whether to obtain or go without coverage transcends state lines and affects everyone throughout the country. The states disagree. But how they're saying no via their lawsuit in Florida is interesting because their argument is based on this: The Commerce Clause only applies to those people who are engaged in commerce. Those who choose not to buy a product are therefore not involved in commerce and the mandate, therefore, should not apply to them. They say the feds cannot force people out of inactivity into activity. The feds counter by saying that because of regulations that compel hospitals to care for people regardless of whether they have coverage or not, that while someone may appear to be inactive, they're really not because they'll eventually need care, they will get it and the rest of us will end up footing the bill via cost shifting (keep in mind that about 20% of our commercial premiums are a direct result of doctors and hospitals charging carriers more to make up for the lack of payments they're getting from the feds and the uncompensated care they're giving to folks who don't have any coverage). In their lawsuit, the states also asked that if the court agreed with them about the individual mandate, that the whole law should be thrown out and ruled unconstitutional. The basis of their argument is that there is no severability clause anywhere in the 2,700 plus pages of the law. A severability clause basically enables the bulk of the law to survive even if a portion of it is thrown out. These clauses are typical in business contracts (such as agent agreements). But there isn't one in the Patient Protection and Affordable Care Act and the states said that it should be thrown out if the mandate goes down.

John Nelson

Claims

Owner Controlled Insurance Program Liability Claims Challenges, Part 3

There is a distinction in the policies, discussed in more detail in this article, between a "named insured” and an "insured.” The rights of the contractor and the application of the policy may be very different if each contractor is a "named insured” or an "insured.”|

Harry Griffith

September 22, 2011

This is the third article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 2, Part 4, Part 5, Part 6, Part 7, Part 8, Part 9, Part 10, and Part 11. Liability Owner Controlled Insurance Program From The Underwriting Perspective (continued) Who Qualifies as Named Insureds? Deciding who qualifies as an insured has a great impact on what risks are ultimately assumed. Does the policy apply to damage caused by contractors at the project; does it include material suppliers; does the program cover design liability, including reworking portions of the project that do not meet the intended strength and stability requirements? Deciding who is not an insured is also important. Any party that is not a part of the Owner Controlled Insurance Program is a source of recovery or offset to a loss covered by the Owner Controlled Insurance Program. There is a distinction in the policies, discussed in more detail below, between a "named insured” and an "insured.” The rights of the contractor and the application of the policy may be very different if each contractor is a "named insured” or an "insured.” Liability Insurance Protects the Contractor, Not the Owner Presenting a Claim The purchaser of the Owner Controlled Insurance Program is the owner. However, the "insured” under a wrap-up policy that is entitled to defense and indemnity is the contractor. There is a natural tension between the owner who wishes to purchase complete protection for himself and the contractors, who are entitled to that protection. Under a liability policy, the carrier defends the insured (each contractor) against claims by others (i.e., the owner) for bodily injury or property damage. Thus, in providing liability coverage, the owner is assuring that the contractor can defend himself and that he has the financial ability to pay the claims. Since the policy covers the contractors, who are entitled to be "defended” against covered claims, the investigation must be conducted on behalf of the "insured,” and all privileges maintained. Accordingly, a liability investigation would be conducted on the part of the contractor, not the owner; absent an agreement to the contrary, the owner is not entitled to any reports on the investigation. In some cases, there is a claim for damage to a portion of the building under construction. In that case, the owner will want that damage repaired and will point to the Owner Controlled Insurance Program, as carrier for the contractors, to do so. It may ask the carrier for the status of the investigation, including the results of any testing that has occurred. However, no liability insurer wants to be accused of waiving its insured's privileges by sharing the reports of investigation with the plaintiff, who is in that case the owner of the project. Therefore, the carrier must be very careful to guard those privileges while promptly handling the claim and in making sure the owner of the project understands this relationship at the outset. Do the Owner Controlled Insurance Program Coverages Work Together? The broker and underwriter need to address the unintended consequences of insuring all parties on the project, while assuring that the endorsements to the liability policy are consistent with the underwriting intent. By way of example, the typical Owner Controlled Insurance Program may contain builders risk, workers compensation, and general liability/umbrella coverage. Here are a few examples of overlapping coverage:

The workers compensation claim by an employee of a subcontractor and a "third party” liability claim by that same employee against the general contractor or another subcontractor (overlapping workers compensation and general liability);
A builders risk claim by the owner for damage to the structure caused during construction and a liability claim against the subcontractor who caused the damage in the first instance (overlapping builders risk and general liability); and
An alleged poor design causes a "loss of use” claim because an affected business is shut down after construction; for example, due to a redirected street. This claim may generate an eminent domain lawsuit (overlapping design E&O and general liability).

The decisions concerning the basic scope of coverage and the overlap with other policies, to the extent they can be anticipated by underwriters, need to be addressed in the policy contracts.

Harry Griffith

Leadership

Designing And Funding Succession And Exit Plans For Successful Business Owners, Part 1

With the help of his trusted advisors, the business owner must understand that, only with proper planning today can the family maximize and protect the value of the years of hard work he/she has put into the company. Attention must be paid to planning for retirement, transitioning to a lesser role in the company, and the impact of his/her own mortality.|

Scott Hinkle

September 22, 2011

Introduction Succession and exit planning for owners of successful businesses is crucial yet challenging. A business owner is typically focused on the bottom line and tied up in the operations of the company. Less immediate issues like ensuring that the business will thrive when he/she is not around, securing a comfortable retirement, providing for the family if something unexpected happens, treating children fairly, and leaving a legacy are critically important to address but receive little, if any, attention. With the help of his trusted advisors, the business owner must understand that, only with proper planning today can the family maximize and protect the value of the years of hard work he/she has put into the company. Attention must be paid to planning for retirement, transitioning to a lesser role in the company, and the impact of his/her own mortality. A comprehensive succession and exit plan considers the central role that the business plays in an owner's overall financial, retirement, and estate plan. When approached on a total needs basis, succession and exit planning present opportunities for the business owner and his advisors to address:

Business continuation. Transitioning the business to a family member, key employee, or third party.
Executive retention. Ensuring continued success of the business through retention of key employees using special benefits (Golden Handcuffs).
Retirement. Securing a comfortable retirement (which is, perhaps, not primarily dependent on the business).
Legacy issues. Preserving the business for family members or monetizing its value to provide financial security for surviving family members while treating heirs fairly.

This is the first of a four-part series addressing succession and exit planning. It is focused on five common business owner situations and the planning strategies to consider in each one. It can help the owner and his advisors determine which type of continuation arrangements to consider depending on the situation at hand. It also contemplates how cash value life insurance is used to strategically fund succession plans. Life insurance often plays a major role in the financial stability of businesses for the same basic reasons as that of an individual: protection against premature death or disability, or retirement, and the delivery of cash exactly when it's required. Situation #1: The business has multiple owners who want to eventually sell their interests to each other. A Buy-Sell Agreement is a legally binding contract which states that upon the occurrence of a "triggering event" (typically an owner's death, disability, retirement, or otherwise separation from the company), the owner's interest in the company must be sold back to the business or to any remaining owners at agreed upon terms. These agreements are crucial for small and closely-held companies, as in many cases, the void created by death or departure of a business owner creates a significant financial burden on the business as well as the remaining partners. When structured properly, a Buy-Sell Agreement allows for continuity of management, a source of income for the business owner and his family, and a clear direction for future ownership of the business. Depending on the type of Buy-Sell Agreement, the business itself or the individual partners acquire a policy on each owner/partner so that upon the occurrence of the triggering event, the funds needed to “buy out” the individual's ownership interest are readily available. To limit this potential risk, most Buy-Sell Agreements are funded with permanent life insurance policies that provide a death benefit in the event of demise as well as a cash value component upon disability, retirement, or departure of the owner. A Cross Purchase Buy-Sell is a specific type of continuation plan best suited for businesses that have only a few owners who want to eventually sell their interests to each other. A Cross-Purchase Buy-Sell Agreement states that, at the occurrence of a triggering event, the departing owners or the estates of the decedent business owners must sell their interests to the remaining owners at an agreed upon or determinable price. The agreement can apply to one or more of the owners; not all have to participate. The participating owners typically purchase cash value life insurance policies on each other in order to fund the future purchase obligation. Each participating owner pays the premiums and is the owner and beneficiary of their respective policies. At an owner's death or departure from the company, the other participating owners use the life insurance death benefit proceeds (at an owner's passing) or cash surrender value (in case of disability or retirement) to purchase the owner's interest. This allows the remaining owners to continue the business with minimal interruption and the departing owner or his estate to walk away with cash. From a tax perspective, it is interesting to remember that the purchasing owners may receive an increase in basis equal to the purchase price of their new interest, but the cash value of the life insurance policy owned on co-owners' lives may be included in the decedent business owner's estate.¹ Since each owner buys a policy on the others, too many participating owners may result in an overwhelming number of life insurance policies. To address this problem, an Entity Purchase Buy-Sell (Stock Redemption) can be used for companies with multiple (three or more) owners who want to eventually sell their interests to each other. The Entity Purchase Buy-Sell requires the business itself, rather than the owners individually, to purchase the participating owners' interests when a triggering event occurs. The business is the purchaser and beneficiary of cash value life insurance policies on each of the participants' lives to be used to fund the future purchase obligation. Upon the triggering event, the business uses the life insurance death benefit proceeds or cash surrender value to purchase the business owner's interest in the company leaving the departing owner or his estate with cash at just the right moment.² Situation #2: The business has multiple owners who want to eventually sell their interests to each other, but the intent may or may not be mutual, so flexibility is desired on how the purchase is ultimately handled. When flexibility is worth a bit more complication, a Wait-and-See Buy-Sell allows the participating business owners to postpone the choice between Cross-Purchase and Entity Purchase Buy-Sell until the death or departure of an owner. It requires the business and the participating owners to purchase the interests at an agreed upon or determinable price upon the occurrence of a triggering event. Usually the business is given the option of first right of refusal; the remaining participating owners can purchase any portion not taken by the business. The participating owners purchase and are the beneficiaries of cash value life insurance policies on the lives of the other participating owners. At the first owner's death or departure from the company, the business decides whether to exercise its purchase option. If it does, the participating business owners contribute funds from the life insurance death benefit proceeds or cash surrender value to the business. The business purchases all or a portion of the shares and the remaining participating owners receive an increase in tax basis equal to their share of the contributions.³ If the business waives its Entity Purchase option or only purchases a portion of the shares, then the Cross-Purchase option may be exercised by the participating business owners. Any outstanding shares must be purchased by the business and funded with contributions from the remaining business owners. Situation #3: The business has multiple owners, some of whom have intent to sell their interests to each other, but the intent is not mutual. A One-Way Buy-Sell is designed for the owner of a business who may want to sell to someone who does not have current ownership in the business or to one or more co-owners that have no reciprocal intent to sell. The One-Way Buy-Sell allows the business owner to have a willing buyer for the interests in the business, the sale of which may provide a source of income for the business owner's family. The buyer is usually a key executive, family member, or third-party to whom the business owner wants to transfer the business. It ensures that the owner can sell his interest to an appropriate buyer, because the agreement requires the buyer to purchase the participating owners' interests at an agreed upon or determinable price upon the occurrence of a triggering event. The buyer purchases a cash value life insurance policy on the business owner's life to fund the future purchase obligation. The buyer pays the premium and is the beneficiary of the policy. The business may provide the buyer (especially if it's a family member or key employee) with a taxable bonus in order to assist with the premium payments. At the owner's death or departure, the buyer uses the life insurance death benefit proceeds or cash surrender value to purchase the business owner's interest. An Entity Purchase Buy-Sell could also be worthwhile to consider in this situation, because it obligates the business, rather than the co-owners, to buy out the decedent or departing business owner's interest in the company. Please refer to description, above. Situation #4: The owner wants to sell business interests to a non-owner, such as a family member, key employee, or third party. Consider a One-Way Buy-Sell; please refer to description, above. Situation #5: The owner has no readily available successor or buyer of the business interests, and would consider having the business become employee-owned. An Employee Stock Ownership Plan (ESOP) is a special type of tax qualified profit-sharing plan that invests primarily in employer securities. If an S or C-Corporation owner does not have an heir, co-owner, or outside buyer interested in taking over the business, or wants the business to end up being employee-owned, an ESOP can be a way to create a source of funds to buy-out the owner's interest in the company. Not only does the Employee Stock Ownership Plan create a buyer for the owner's stock, but a C-Corporation business owner can use the sale proceeds to purchase qualified replacement property and defer taxation on the sale of the stock to the Employee Stock Ownership Plan. This allows the owner to sell all or a part of the business to the Employee Stock Ownership Plan without immediate taxation and to use the proceeds to diversify assets through the purchase of qualified securities. After a company feasibility study is conducted and approved for an Employee Stock Ownership Plan, the company establishes and makes tax-deductible contributions to a trust. All full-time employees with a year or more of service are typically included. The company contributes new shares of its own stock or cash to buy the existing shares of stock from an owner who desires to sell. In today's low interest rate environment, it may make sense for the Employee Stock Ownership Plan to borrow the money to buy new or existing shares, with the company making cash contributions to the Employee Stock Ownership Plan to repay the loan. Once the stock is in the Employee Stock Ownership Plan, it is allocated to the accounts for the individual employees on a non-discriminatory (qualified) basis and it vests over time. When employees leave the company, they receive the vested Employee Stock Ownership Plan shares, which the company is typically required to buy back at an appraised fair market value. Cash value life insurance owned by the company is oftentimes used to fund the company's repurchase obligation. Policy cash values can accumulate tax-deferred and can potentially be accessed income tax-free for annual stock repurchases. In addition, any death benefit proceeds paid may be received by the company income tax-free, and can create an immediate source of funds for stock repurchase in the event of an untimely death of a major participant or shareholder. Conclusion I hope you found this article intriguing. Part 2 of this four-part series will address executive retention as a way ensure the continued success of the business through attracting, rewarding and retaining key employees with special benefits. ¹ Neither Grant, Hinkle & Jacobs nor Insurance Thought Leadership is a tax or law firm and this is not meant to be relied upon as tax advice or to avoid IRS penalties; please consult your tax and/or legal professional before embarking on any business succession plan. ²The death benefit proceeds, although typically income tax-free to beneficiaries under IRC §101(a)(1), are taxable to the employer unless it qualifies for an exception under IRC §101(j). ³ See ¹, above. ⁴ See ², above.

Scott Hinkle

Scott Hinkle is a Shareholder of Grant, Hinkle & Jacobs, Inc., located in Solana Beach, California. Mr. Hinkle has over fifteen years of experience in the financial services arena. He specializes in the development and implementation of advanced business succession and estate planning strategies for business owners and high net worth individuals.

Leadership

Shouldn't Your Insurance Coverage Become More Than An Expense?

Chuck Coppage

September 21, 2011

Most businesses buy their insurance coverage and while it may seem expensive they are content knowing that unforeseen circumstances driven by an unforeseeable event won't financially devastate their company. What if there was a way to shift this traditional model? I think there are a great many of us who have had the thought that if my premiums aren't used to pay losses for my business why shouldn't I get some of that money back? After all, why should the insurance company make a windfall profit because I do a great job of risk management and preventing losses before they happen? The purpose of this article is to tell you that there is a way to recoup part of your premiums, while still getting competitive premiums. Insurance is a financial transaction as well as a way to purchase protection for your business. Most of us are familiar with the basics of paying premiums, checking to be sure we have adequate limits of insurance and can tolerate the cost of a claim under our selected deductible. At the same time, we aren't nearly as familiar with the way our premiums are used by the policy issuing Insurance Carrier. Insurance Carriers use a pooling system to provide protection to policy holders and at the same time maintain adequate financial reserves sufficient to pay claims individually or in the event of a catastrophe. By pooling premiums Insurance Carriers need to write a mix of accounts, both low hazard as well as higher hazard. In addition, the pool needs a balance of profitable and unprofitable accounts, which creates a subsidy for the unprofitable accounts, but enough premiums in the aggregate to pay all claims. The ultimate goal of the Insurance Carrier is to break even or maybe make a small profit when considering a traditional balance sheet review of their business revenues versus expenses. Unlike many other businesses, the Insurance carrier has a second and more rewarding way to generate profits from the insurance transaction. This additional source of profits is carried on their balance sheets as both assets and restricted assets in the liability column. A simple example of how this works is easily seen in life insurance. The Insurance Carrier can issue a policy with a 1 million dollar benefit and pay that amount the next day in worst case situations. Obviously, the carrier didn't collect the full premium nor will they on that policy. The assets held on the balance sheet as restricted assets are used to pay this loss. The same dynamics work with the same characteristics in business insurance. The principal lines of business coverage are workers' compensation, auto liability, general liability and health insurance. The existence of restricted assets on the insurance carrier's balance sheet is also the source of investment income. These assets in commercial insurance are primarily reserve dollars set aside after the occurrence of a claim that are not yet paid. In addition, the carriers set aside reserves allocated for claims, but not yet allocated to a specific claim. Over a period of years these restricted assets can grow to be several times the annual premium written by the Insurance Carrier. Restricted Assets are invested in secure non-equity investments such as bonds until needed to make claims payments. In many instances, the insurance carrier can generate investment income in the range of 5-50% of annual premium income. This allows insurance carriers to cover unexpected losses and have capital available for growth of their policy count with new business. Business owners need to know that there are programs and insurance coverage methods that will allow them to take advantage of these income streams for their own benefit. Insurance carriers, while accustomed to taking risk when writing insurance policies, are very comfortable giving up the income potential in return for policyholders taking a portion of that risk. Working for only fee income allows insurance carriers to increase income while limiting risk. At the same time, moving to a program with an alternative structure is a good option for a business. It allows a business to reduce insurance cost through recapture of premiums as dividends. It is a "win-win" situation for everybody and allows a business to build an asset while continuing to protect their business against catastrophic losses. A careful feasibility study can be completed that will quantify the risk/reward equation for a business owner. Completion of the feasibility study will allow a business to make an informed decision as to whether taking a defined risk is adequately rewarded with reduced cost and dividends, over time. In addition to building assets on your balance sheet with an alternative approach to insuring risk, you can also gain better oversight of your insurance costs and claims management. Every company of average size should consider having a feasibility study completed. If you are interested in having such a study completed for your company, feel free to contact me.

Chuck Coppage

Chuck Coppage manages the Alternative Markets Division for <a href="http://www.iwins.com">InterWest Insurance Services</a> where he assists in identifying clients who would benefit from insurance solutions involving risk transfer as part of their overall financial management strategy.

Claims

Owner Controlled Insurance Program Liability Claims Challenges, Part 2

In the context of underwriting risks associated with an Owner Controlled Insurance Program, there are four critical issues: (1) marketing, (2) determining who qualifies as named insureds under the program, (3) remembering that the policy protects the contractor rather than the owner for many claims, and (4) how the liability policy interacts with other Owner Controlled Insurance Program coverages.|

Harry Griffith

September 21, 2011

This is the second article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 3, Part 4, Part 5, Part 6, Part 7, Part 8, Part 9, Part 10, and Part 11. Liability Owner Controlled Insurance Program From The Underwriting Perspective In the context of underwriting risks associated with an Owner Controlled Insurance Program, there are four critical issues: (1) marketing, (2) determining who qualifies as named insureds under the program, (3) remembering that the policy protects the contractor rather than the owner for many claims, and (4) how the liability policy interacts with other Owner Controlled Insurance Program coverages. Marketing The starting point for any insurance relationship between a sophisticated carrier and a project owner is through brokers in an arms-length transaction. The insured (or its broker) presents a risk to the insurance company and requests that coverage be quoted. The insurance company decides whether it is interested in that risk and the amount that it will charge in its premium. In marketing the Owner Controlled Insurance Program, however, the underwriter may become actively involved in convincing the client that the insurance company is the best to underwrite such a large and sophisticated risk. As discussed below, the owner is often the party seeking damages from an enrolled contractor for damage caused by the latter's work. The owner is thereby a potential claimant as well as the named insured. Statements concerning coverage therefore need to be measured carefully. The underwriter or marketing representative is an employee or an authorized representative of the insurance company. He or she is an agent of the insurance company binding the principal to his statements. (Marsh & McLennan of California, Inc. vs. City of Los Angeles (1976) 62 Cal.App.3d 108.) A statement made by an agent is binding upon his or her principal, as if the principal itself had made the statement. (California Civil Code §2298, et seq.; House of Grain vs. Finerman & Sons (1953) 116 Cal.App.2d 485.) Statements made in the marketing of an Owner Controlled Insurance Program have the potential to create confusion and resulting tension. Some of the more common areas of misunderstanding we have encountered include the following: Who is responsible for explaining the Owner Controlled Insurance Program coverage, deductibles, etc., to the prospective insureds? As to the sponsor of the program, the owner, the broker will have the relationship and ordinarily represent their interest in the transaction. However, what about the contractors? We have experienced claims where contractors claim that simply setting foot on the Owner Controlled Insurance Program insured project entitles them to coverage. Exactly what is the process to become enrolled in the insurance program, and when does coverage become effective? In many cases it is the issuance of a workers compensation policy. However, sometimes there is a lapse in the paperwork, and a job site accident occurs before the enrollment is completed. There are ways that Owner Controlled Insurance Program administrators have created to document enrollment. As a general matter, problem areas exist whenever there is an issue beyond the terms of the insurance policy as issued. The owner, broker, and underwriter need to be aware that the ultimate "insureds” under the program are not a part of the marketing and program design. Communications that do not clearly spell out the rights and responsibilities of all the program participants can lead to confusion or, worse, to coverage gaps and uninsured losses which in turn lead to litigation for all of the parties, including the broker, the sponsor, and the carrier.

Harry Griffith

Claims

Owner Controlled Insurance Program Liability Claims Challenges, Part 1

Owner Controlled Insurance Programs, or OCIPs, are the logical consequence of insurance underwriters and project owners trying to control costs and speed the resolution of construction-related insurance claims (including builders risk, workers compensation, and liability claims).|

Harry Griffith

September 20, 2011

Owner Controlled Insurance Programs (OCIPs) present unique challenges in settling claims. Critical aspects of the underwriting process directly affect how coverage will apply to covered contractors and subcontractors. This series examines critical policy provisions that will impact the claims process and offers strategies for smoothing the claim resolution process. A variety of challenging Owner Controlled Insurance Program scenarios will be used to guide brokers, claim professionals, and underwriters in the settlement of claims. This is the first article in an 11-part series on Owner Controlled Insurance Programs. Subsequent articles in this series can be found here: Part 2, Part 3, Part 4, Part 5, Part 6, Part 7, Part 8, Part 9, Part 10, and Part 11. Owner Controlled Insurance Programs, or OCIPs, are the logical consequence of insurance underwriters and project owners trying to control costs and speed the resolution of construction-related insurance claims (including builders risk, workers compensation, and liability claims). Indeed, it would be difficult to find an experienced claim manager who has not slapped his head (or someone else's) in exasperation over the amount of time and money that it takes to resolve a construction bodily injury or construction defect claim. For owners, there is a built-in incentive to find a better way to more efficiently manage the claims that inevitably occur on a large construction project. The amount of money spent on insurance premiums is a significant portion of the cost of construction. Moreover, the amount of money spent, not to mention the time commitment, is substantial because of the number of people and interests to protect. From an insurance company's perspective, an Owner Controlled Insurance Program premium is significant. Further, the ability to receive the premium for all parties on the job site while simultaneously eliminating the allocated expense makes Owner Controlled Insurance Programs an attractive underwriting risk. An Owner Controlled Insurance Program, or wrap-up policy, may include all or part of the insurance needed on a project, including builders risk, workers compensation, and liability insurance. Experienced professionals in each line of insurance each have their own unique perspective on the process and the effect of insuring all parties on the project. Here, we concentrate on liability claims and policies. As viewed from the perspective of the people who are attempting to resolve liability claims under an Owner Controlled Insurance Program, the industry is maturing. Underwriters, owners, contractors, construction managers, and brokers are becoming more sophisticated with regard to underwriting and claims presentation. Specifically, in our practice we have noted the following trends in the handling of such claims "in the trenches”:

Owners, as the sponsor of the program, assert control over claims under the insurance program, which can create tension with the insurance company and the contractors on the project.
Brokers are increasingly sophisticated and acting as coverage advisors for the insureds to maximize recovery under the Owner Controlled Insurance Program policies.
There are often differences between the insurance policy issued by the company and the coverage as represented to enrolled subcontractors.
There is an increasing tendency for owners, brokers, and contractors to treat the Owner Controlled Insurance Program as a single program, a concept that is sometimes at odds with the concept of liability insurance.
Inconsistencies between liability policy language, Owner Controlled Insurance Program manuals provided to contractors, and the actual subcontracts blur the definition of what is the governing Owner Controlled Insurance Program contract.
Lack of complete enrollment by all subcontractors on the project or phase complicates the claims process and impacts the cost of the program.
The timing of the inception of a "rolling wrap” can create hybrid liability claims that are partial wrap and partial non-wrap for purposes of a construction defect claim.
Lack of sophistication by subcontractors and their counsel creates tension in the claims process.

The insured contractors must bear in mind what an Owner Controlled Insurance Program is and what it is not. An Owner Controlled Insurance Program is an insurance policy, intended to provide all of the contractors on a job site with necessary coverage. From the perspective of the claims department, the Owner Controlled Insurance Program is not a new kind of insurance. Therefore, this series concentrates on applying existing rules in the context of an all-encompassing policy.

Harry Griffith

Risk Management

Translating Safety Management Compliance

Requiring safety management programs is not an either/or dilemma of compliance or safety, and effective safety management does reduce injuries and associated costs.|

Russell Lee

September 15, 2011

OSHA is currently in the process of developing an Injury and Illness Prevention Program (I2P2) management standard intended to be extended to all fifty states. As California is one of only fourteen states to currently have a safety management program requirement in place (Title 8, Section 3203), significant attention has been paid to California's program, the perceived costs and benefits of making safety program management mandatory, and the lessons learned along the way. Besides cost-benefit, another issue that is often raised is whether mandated compliance, through threat of citation and/or poorly conceived requirements, actually diminishes levels of safety. Dan Petersen, a well-regarded safety professional wrote, "Most organizations I am familiar with have come to believe that, when it comes to safety and health, they have two distinct concerns, which seem to have little to do with each other: preventing accidents and regulatory compliance." Based on my experience, both as a safety director and a risk management consultant, I am of the opinion that requiring safety management programs is not an either/or dilemma of compliance or safety, and that effective safety management does reduce injuries and associated costs. The fundamental issue has been one of translation — which is to say that the companies that struggle with safety management (as opposed to those that reject the requirements out of hand) are simply unable to translate safety requirements into manageable and sustainable day-to-day policies and procedures, and they ultimately give up. This is an issue Cal-OSHA has addressed but not overcome. On July 15, 2011, John Howard, Cal-OSHA Chief, gave a presentation entitled Injury and Illness Prevention Program: The California Experience, in Washington D.C. to the Small Business Roundtable. He summarized the pitfalls encountered rolling out the requirement and Cal-OSHA's efforts at supporting implementation (translation). I have not found the transcript of the presentation, but the supporting PowerPoint provides a good overview of the specific topics he touched on. Early criticisms of SB 198 were that it was “overly broad and burdensome” and that many employers lacked the expertise to develop (translate) requirements into an effective program. Within three years of enactment, the legislature had modified some requirements and Cal-OSHA had produced several model programs (translations) that could be used by a variety of businesses. The programs were followed with the introduction of compliance checklists (translations) that were intended to guide users to the regulatory top of the mountain. However, and as Howard notes, the downside of these support tools was that they often resulted in “paper compliance” that did nothing to enhance actual safety management. What he did not note is that they also did not provide effective compliance translation. Currently Cal-OSHA Consultation provides on-site assistance and has developed a variety of eTools, including an online IIPP “wizard” to support companies with the development and implementation of their Injury and Illness Prevention Program. Unfortunately, many companies are leery of requesting on-site help, and it is not at all clear whether the web-enabled support helps companies struggling with the core issue of day-to-day management of their safety program. I do not believe that it does, and would offer the following suggestions to those who have struggled with IIPP implementation:

Cal-OSHA starts with the written program. You should not (but do keep your old program intact while you build the new one).
Do start with the supervisors who oversee the productive part of whatever you do.
Introduce a weekly or bi-monthly form that documents day-to-day behavior reinforcement. A month later add a weekly safety assessment/fix to the mix, the next month add weekly group meetings, all on the same form. Provide training and define expectations as each new component is added. To effectively support these required activities create forms that must be filled out completely in a given time frame. The frequency of completing a form can be adjusted depending on risks inherent in a work area, but the form should always be designed to be filled out completely in any given cycle. Learn about performance support and job aids, and develop multi-level performance support forms to guide and document your program. Job Aids Basics – Joe Willmore Job Aids & Performance Support – Allison Rossett & Lisa Schafer A simple checklist-style form that includes only basic details can guide and capture essential activities — including behavior reinforcement, safety assessment/fix, and tailgate training. Keep each form to a single page. Also, consider desktop/smart phone/tablet applications as alternatives to paper forms.
This approach is completely scalable. Delegate to all departments and levels — design interlocking performance support forms that culminate in a monthly Safety Activity Report submitted by the safety manager to the owner/CEO. If supervisors are required to engage in behavior support conversations, then the department manager's monthly form should include confirmation that the supervisors are fulfilling the required behavioral support activities and an assessment of the quality of their work, and so on.
Look to the Injury and Illness Prevention Program requirements for those activities that should at some point be integrated into the Safety Performance Support Forms — likely activities include either doing, assessing, or assuring the doing of: behavior enforcement and reinforcement; training (new employee, new hazard, tailgate, etc.); inspection; day-to-day hazard identification and correction; accident investigation; employee suggestions, and so on.
Incorporate other compliance areas (HazCom, Heat Illness Prevention, Lockout/Tagout) into your performance support forms as training, inspection, and behavior reinforcement activities.
Six months after you start this process consider rewriting your IIPP to reflect what you are actually doing.

Download a sample form that will help you begin.

Russell Lee

Russell Lee is not a risk management consultant; he is an organizational change consultant with extensive experience in risk management and loss prevention. He provides companies with the tools and guidance to develop the internal processes and linkages to effectively and sustainably manage risk and reduce losses.