The management of the risks that their organization encounters is a key responsibility of legal departments. Insurance is a crucial tool for transferring risk since it allows a financial institution to take on all or part of the risk.
Insurance contracts are mostly legal agreements with a few unique characteristics and risks. Therefore, it is crucial that the legal department participate in the risk transference process. The following duties should be carried out by the legal department:
- identifying the risks that are intended to be transferred via insurance in coordination with risk management staff;
- confirming that the risk transfer is actually accomplished by the policy's terms - while insurance intermediaries are experts in insurance coverages, the majority lack legal training;
- safeguarding the fairness of the application process since false statements made in an application might cast doubt on the entire policy;
Coordinating with risk management
An increasingly essential field demanding discipline, resources, and knowledge is risk detection and management. An organization might suffer harm, become unable to function, or even perish due to operational, reputational, liquidity, technical, regulatory, and reputation threats. With some firms having specialized departments and even Chief Risk Officers, risk identification and enterprise-wide risk management are now crucial disciplines. Both the public's and regulators' expectations of how businesses should approach risks are constantly changing. For instance, the SEC to the President in the United States have issued directions to address the new and quickly evolving danger of cyber-risk. Risk is becoming an increasingly important part of the governance monitoring that boards of directors are responsible for.
Commercial firms have been creating systems to share and/or transfer all or portion of the risks they encounter since the dawn of time. Insurance has been a crucial risk transfer tool for hundreds of years, and in the western world, all businesses purchase insurance. Over the years, regulations and judicial rulings in common law jurisdictions have created specific rules for insurance contracts and their interpretation. These present opportunities and problems for organizations, which individuals with legal expertise are well-suited to handle.
It takes a multidisciplinary approach to identify the risks that the organization faces, decide which can be insured, how much can and should be insured (insurance limits), and how much it will cost. The market, the risk officer or department, and the insurance intermediary are all involved.
Important legal documents, like other significant legal agreements, the rules to transfer these risks should be reviewed by the legal department.
Insurance Policies
The majority of insurance contracts follow a similar format: coverage clause(s) that outline the risk being taken on by the insurer; exclusions that limit the risks assumed; definitions; limitations to coverage and reporting claims, including the matter of claim defense; and general terms. A few of these components may become entangled depending on the policy's origin and scope of coverage. Exclusions may be included in definitions. There may be carve-backs in exclusions that exempt some things from being excluded. It is customary for endorsements, occasionally numerous endorsements, to augment (amend) broad policy provisions.
Important policy frameworks and methods of interpretation that the courts have evolved over time, including the following:1
- Policies may be based on claims- or occurrence-based contracts.
- Regardless of when the claim is filed, pure occurrence-based insurance cover claims resulting from events that took place during the policy period. Most property insurance policies and some older liability insurance are occurrence-based. It is crucial to keep track of these policies because failing to do so could jeopardize your ability to file a claim.
- Purely claims-based insurance covers losses sustained during the policy period, regardless of when the triggering event took place. This type of liability policy is common and includes Directors & Officers and Errors & Omissions Policies.
- According to court rulings, insurance policies are subject to the standard guidelines for contract interpretation. However, courts acknowledge that most insurance contracts are not negotiated but rather prepared by the insurers, and as a result, they have established the following rules:
- The insured must demonstrate that the coverage clause applies to the claim in question. However, coverage provisions should be read broadly in the insured's favor.
- The burden of proving an exclusion transfers to the insurer once the insured has established that the insurance provision is applicable. Exclusions must be strictly construed, again in the insured's favor.
- If there is a question, it must be answered in the insured's favor.
- The insured's reasonable expectations may be utilized to interpret a policy when it is unclear.
- Insurance companies' long-standing stance does not guarantee that the courts will agree with it. The term "accident," which is central to many insurance policy coverages, had a clear definition for a long time before the Supreme Court of Canada finally gave it one. 2 A Comprehensive General Liability policy was recently interpreted by the Supreme Court of Canada differently from how insurers had been viewing it for decades, favoring an insured. 3
- Insurance policies have some flexibility. To deal with a definition or word that is improper for your organization, bring it up and get the policy endorsed. Examples in the context of Directors & Officers policies include income trusts and unanimous shareholder agreements.
- The insurance sector is infamous for delivering a certificate of coverage but holding off on delivering the terms of the policy contract. Having the policy contract provisions spelled out clearly can be significant, as seen by the billions of dollars in claims resulting from the 9/11 events that were examined based on whether the policy considered it as one occurrence or two. In this regard, legal departments may apply some discipline.
- As you might anticipate, insurers alter their policies to reflect judicial decisions. Older documents, however, might have different language and, as a result, apply in various ways. This is especially true for outdated liability plans that cover claims for pollution.
The Application Process
To secure coverage, the insurance application must be accurate. The courts have ruled that whether or not the application expressly addresses the fact, the insurer may void the policy if a material fact is misrepresented (including by not disclosing it) and is objectively reasonable for an underwriter to consider when deciding whether or not to accept the risk or set the premium.
The legal department should be aware of what the policy covers, who needs to be included in the disclosure, and that there are processes in place for such comprehensive disclosure to be made because the application is the foundation of the coverage.
It may be particularly useful to involve individuals with legal training in particularly complex areas of the application form because lawyers are also educated to make disclosure in a way that is most advantageous to the company. 4
Information that is being disclosed may be confidential, privileged, or proprietary. The legal department should make sure that the proper legal protections are put in place to protect the business or the privilege, just like in other disclosure circumstances.
If it turns out that a major misrepresentation was made, the legal department may be able to fix the problem before a claim occurs, at which point it will be challenging, if not impossible, to implement remedies.
This article was mostly generated using the AI tools, OpenAI ChatGPT and Google Bard.