Barg Coffin Lewis & Trapp, LLP Articles

October 1998

Insurance for Employment-Related Claims

Coverage under traditional products and the new employment practice liability insurance

by Jon Enscoe

There has been a virtual explosion of discrimination, wrongful termination, sexual harassment and other employment-related claims against businesses in recent years. In response, employers have taken steps to minimize the risks of such claim by improving their employment policies, procedures and training.

Employers also have looked to their insurance carriers to defend against and sometimes pay for these claims. Unfortunately, insurers universally have vigorously maintained that traditional insurance products, such as commercial general liability (CGL) policies and directors and officers D&O policies do not cover employment-related claims. In addition to litigating such claims aggressively in the courts, insurers also have modified traditional insurance products expressly to exclude coverage for employment-related claims. In general, the courts have accommodated the insurance industry by issuing a series of pro-insurer decisions in this area. As a result of these developments, it is now very difficult to obtain insurance coverage for employment-related claims under traditional insurance products.

However, at the same time that insurers have resisted coverage under traditional insurance policies, they also have been developing and promoting new types of insurance products designed specifically to cover employment-related claims. This article examines the prospects for obtaining coverage under traditional insurance products and describes the relatively new Employment Practice Liability Insurance policies on the market.

General Liability Policies

The commercial general liability policy (often referred to as a CGL policy) is the basic type of insurance that businesses purchase to protect against third-party tort claims. A CGL policy typically consists of fairly standardized forms prepared by an insurance industry trade group. These policies typically provide coverage for bodily injury, property damage, advertising injury and personal injury, as those terms are defined in the policies, but generally not for breach of contract claims.

Several years ago, it was not uncommon for businesses to obtain at least a defense, and possibly indemnity coverage, for employment-related claims under CGL policies. However, for a number of reasons, CGL policies generally are of little value to businesses faced with these claims today First, California courts have held that typical employee claims for lost wages or other economic losses do not constitute property damage as defined in a CGL policy. See, e.g., Waller v. Truck Ins. Exchange, I I Cal.4th (1995). Therefore, the property damage coverage of CGL policies typically is not invoked by an employee claim.

Second, while employees often seek damages for emotional distress (among other damages), employers seldom have success tendering such claims to their CGL insurers under the bodily injury coverage provision. Bodily injury typically is defined as "bodily injury, sickness or disease, including death resulting therefrom." A number of court decisions in California during the 1990s have made it very difficult to obtain coverage for these emotional distress claims. See, e.g., Chatton v. National Union Fire Ins. Co., 10 Cal.App.4th 846, 854-855 (1992) (no coverage for emotional distress in absence of physical injury); Waller (no coverage for emotional distress related to economic losses, even if accompanied by physical injury).

Third, standard CGL policies require that the damage or injury be caused by an "occurrence," which is defined to require that the acts giving rise to the claim be accidental. Most California cases that have addressed the issue have held that termination and sexual harassment are inherently intentional acts that do not constitute occurrences, and that they therefore do not trigger coverage. See Loyola Marymount Univ. v. Hanford Accident & Indemnity Co., 219 Cal.App.3d 1217, 1224-1225 (1990) (wrongful termination); Coit Drapery Cleaners, Inc. v. Sequoia Ins. Co., 14 Cal.App.4th 1595, 1606-1607 (1993) (sexual harassment).

In addition, some courts have held that there can be no coverage for claims of unlawful termination in violation of public policy, sexual harassment or discrimination based on California. Insurance Code section 533, which precludes coverage for "willful acts." See B & E Convalescent Center v. State Compensation Ins. Fund, 8 Cal.App.4th 78,93-102 (1992).

Finally, in the past several years, almost all insurers have added to their CGL policies an extremely broad provision expressly excluding coverage for bodily injury in all employment-related claims. Coverage still may be found in a variety of circumstances such as where the policy has non-standard provisions, the particular insurance company has not added an employment-related claims exclusion or there are uncommon allegations in the employee's complaint. However, as a result of these developments, CGL coverage has been eliminated for most employee-related claims.

Directors and Officers Liability Policies

If an employee's claim is directed against an officer or director, the company's Directors and Officers Liability D&O policy also should be reviewed for possible coverage. The typical D&O policy indemnifies a corporation's directors and officers for covered losses that they sustain for wrongful acts committed in their capacities as directors and officers. In addition, a D&O policy generally will reimburse a corporation for covered amounts that a corporation pays to indemnify these employees.

This policy, however, provides inadequate coverage in the majority of employment-related cases because D&O policies typically have provided coverage only for directors and officers who are named in a complaint. and not for other employees. In addition, the corporate entity itself is not covered by the typical D&O policy for claims made directly against the entity, although some more recent D&O policies (usually available only to nonprofit organizations) do provide coverage for the entity. Finally, in recent years, many insurers have added endorsements to their D&O policies excluding coverage for employment-related claims.

Similar policy modifications and adverse cow rulings in recent years also have eliminated any significant possibility of coverage for employment-related claims under workers' compensation policies. E.g., La Jolla Beach & Tennis Club, Inc. v. Industrial Indemnity Co., 9 Cal.4th 27,46 (1994).

As a result of adverse court rulings and policy modifications specifically designed to avoid coverage, traditional types of insurance policies usually are of little value to a business facing a termination, discrimination or sexual-harassment claim by an employee. Nevertheless, these policies should not be ignored as they sometimes will at least require an insurer to provide a defense, depending on the language of the particular policy and the specifics of the claim. In addition, if the claim alleges events that occurred years ago, earlier policies with more favorable coverage provisions may be triggered.

Employment Practices Liability Insurance

While insurance companies have been fighting coverage for employment-related claims under traditional policies, they simultaneously have developed and offered new insurance products designed specifically to cover these claims—Employment Practices Liability Insurance policies. EPLI policies are not standardized and vary substantially from one insurer to another with respect to what is covered and to what extent. They typically provide coverage for claims of discrimination, unlawful termination sexual harassment and sometimes related claims such as failure to hire or promote. EPLI policies are issued on a "claims-made" basis, meaning they only provide coverage for claims made during the policy period, as opposed to CGL policies, which provide coverage for damages which occur during a policy period without regard to when the claim is made.

As recently as a few years ago, the few EPLI policies available provided only for the payment of defense costs and not indemnity (the cost of settlements and judgments). However, more and more insurers have become comfortable enough in their ability to manage and control this type of risk, and today offer defense and indemnity EPLI policies as well as those providing only for a defense. The demand for EPLI policies has increased substantially in recent years due to the increasing number of employee claims and the decreasing coverage under other types of insurance policies. Today more than 30 insurance companies offer these products and a Wall Street Journal article last year estimated that nationwide as many as 10,000 businesses have purchased EPLI policies.

Compliance for EPLI Policies

EPLI policies cannot be obtained without completing a lengthy and detailed written application. As part of the process, the insurance companies carefully scrutinize the company's policies and procedures, including employment application forms, employee handbooks, policy manuals and the company's employee-related claims history. An insurance company is unlikely to issue an EPLI policy, or will do so only for a very high premium, if the company's employee policies and procedures are found wanting. The vigorous application process is the means by which insurance companies manage the risks under these policies; it therefore pays to have your policies and procedures in order before applying for an EPLI policy.

Defense Only or Defense and Indemnity?

There are two basic types of EPLI policies. Some policies provide both (1) indemnification for damages, including settlements and judgments, and (2) payment of legal expenses. Under this type of policy, the insurance company almost always has the right to select counsel and largely controls the defense and settlement decisions (some policies require the employer's consent to a settlement). However, insurers sometimes, but not always, will negotiate on the selection of counsel. It is important that an agreement be made with the insurance company regarding who selects counsel and what billing rates will be paid before the inception of the policy.

Some insurers also offer a "defense-only" policy, at a substantially lower premium. Under these policies, the insurer pays attorneys fees and other defense costs, but not settlements or judgments. A policyholder is more likely to be able to select its own defense counsel and control settlement decisions under a defense-only policy.

Before selecting a policy, each employer needs to consider the value of selecting its own counsel and having substantial control over its defense and settlement decisions, keeping in mind that an insurer-selected counsel may have institutional loyalties to the insurance company as opposed to the employer. This is particularly important in employment-related lawsuits, which are likely to have effects on an employer far beyond the potential for damages in that individual lawsuit. For example, how a lawsuit is handled can affect the morale of employees and the employer's reputation, and may either deter or encourage future claims.

The employer may want the ability to settle a claim before trial even though it may be a defensible case or, conversely, the employer may want the right to defend the case vigorously through trial even if it could be settled cheaply, in order to discourage future litigation. In addition, even though a defense and indemnity policy will cover most damages, there often will be the potential for damages for which the business will remain liable, such as damages in excess of the policy limits and punitive damages, which, as a matter of law, cannot be insured in California.

For these reasons, some employers will prefer an EPLI policy that gives the employer the power to select its own counsel, and to control decisions regarding settlement. This is more likely to be available under a defense-only policy. Other employers may prefer a defense and indemnity policy and be happy to leave defense and settlement issues to the insurance company and its selected counsel, because the insurance company will in most instances be responsible for both defense costs and a settlement or judgment.

EPLI Policy Cost

It is common for EPLI policies to provide for $1 million in coverage limits, although policies in much larger amounts are now available from many insurers. Defense costs are generally included in the limits, so in deciding how much coverage is needed, an employer must take into consideration that limits available for settlement or judgment will be reduced by the cost of defense. Deductibles for a $1 million policy typically range between $2,500 and $25,000, and there may be a co-insurance payment, typically 5 to 10 percent, although many insurers have eliminated this requirement. Typically, the larger the deductible and/or co-payment, the less expensive the policy.

The cost of an EPLI policy will depend on a number of factors, including the size of the employee population, the company's employee-related claims history and the quality of the company's risk management program, such as its employee procedures and policies. As a rough estimate, a company with good risk management procedures and a clean record can probably obtain a $1 million defense and indemnity policy for between $60 and $80 per employee annually. For example, a $1 million policy with a $15,000 deductible for a company of 100 employees might cost $7,500 annually. The cost of a defense-only policy can be up to 50 percent less.

Policy Terms

EPLI policies are not standardized, and numerous terms—some very important—vary significantly from policy to policy. Following are a few of the most important terms:

(1) Exclusion For Intentional Acts. As discussed above, in the context of analyzing coverage under CGL policies, some courts have held that sexual harassment discrimination and termination claims are inherently willful acts, and that coverage therefore is barred under Insurance Code Section 533. The sweeping language of a few cases has even cast doubt on the efficacy of EPLI policies that are designed specifically to cover such employment-related torts. However, recent cases have repudiated the broad language of some of the decisions of the early 1990s, and have recognized that most employment-related torts are not inherently intentional from the standpoint of an insured company, and that Section 533 does not necessarily preclude coverage for such claims. See. e.g., David Kleis Inc. v. Superior Court, 37 Cal.App.4th 1035, 1050-51 (1995); Melugin v. Zurich Canada, 50 Cal.App.4th 658, 665-666 (1996). These recent cases give substantial assurance that insurers are free to sell, and companies are free to buy, liability insurance for sexual harassment, or discrimination that the employer did not specifically intend. In addition, courts will undoubtedly be less receptive to an insurer who denies coverage after collecting the premium for a policy that is specifically designed to cover employment-related torts.

Some EPLI policies contain an exclusion for intentional acts, while others do not. An employer should avoid any policy that excludes coverage for intentional acts, either directly or by stating that no coverage is provided if it would be against public policy.

(2) Discrimination. EPLI policies are named peril-policies, meaning that they only provide coverage for the type of claims specifically named in the policy. The policies all cover discrimination—but the definition of discrimination varies widely. It is important to obtain a policy that will cover any type of discrimination claim an employee can make. and not just specified types of discrimination.

(3) Claim. Most policies include within the definition of a "claim" any demand (or sometimes a written demand) for money. Certain other policies, however, do not consider a demand a "claim" unless and until the employee files a lawsuit or initiates an administrative proceeding. When selecting a policy, confirm that a written demand for money is considered a claim so that the insurer's obligations (including providing a defense) start early, and the insurer cannot avoid coverage on the ground that no claim was made during the

policy period. On the other hand, it is probably preferable to not include oral complaints within the definition of a claim. It would seem very difficult to track and report every oral complaint, and this could therefore jeopardize coverage, since policies generally contain a time limitation on reporting claims.

(4) Insureds. It is important to get a policy that includes all employees as insureds under the policy. Some policies only include supervisory level employees as insureds. This is inadequate, because non-supervisory employees sometimes are named in harassment lawsuits.

(5) Exclusions. Will the exclusions make the policy less valuable? There are a wide variety of exclusions in EPLI policies, and they vary substantially from policy to policy. For example, some policies exclude coverage for class actions, for claims resulting from significant corporate downsizing or for proceedings before the National Labor Relations Board. It is important to carefully review the list of exclusions and determine if any listed exclusion is an area of particular risk for the employer. If so, another policy may be available without the particular exclusion, or the exclusion may in some cases be removed by endorsement.

Conclusion

It has become increasingly difficult to obtain coverage for employment-related claims under traditional insurance policies. Employers who have not done so should consider whether it makes good business sense (and whether it is worth the cost) to purchase an Employment Practices Liability Insurance policy. These policies vary considerably, so take care to select a policy that satisfies the particular needs of your business.

These materials are provided for information purposes only and are not intended as and cannot be considered legal advice. Before taking action based upon this information, you should consult your legal counsel.

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