In the ongoing saga of AIG and its contribution to the economic earthquakes of the last several months, state insurance commissioners countrywide have shown no shame in stealing one of the "Star Wars" lines made famous by Han Solo and Lando Calrissian: "It’s not my fault!" Seems good old property-casualty insurance is country simple compared with those high-falutin’ financial geehaws dreamed up by fancy-pants city slickers!
One can only assume the good commishes haven’t taken a recent look at contractual liability transfers and hold harmless agreements. What inspires this thought is the following quote from an article titled "Derivatives: The Risk That STILL Won’t Go Away" from the July 6 issue of Fortune:
A basic reason for favoring regulation is that derivatives created a kind of mirage. They don’t extinguish risk, they simply transfer it to a different party—a counterparty, as the term goes. The ultimate outcome is millions of contracts and an endless, virtually unmapped, web of connections among financial institutions. That maze exists today, and so does the systemic threat it raises: that some major counterparty will go bust and drag down other institutions to which it is linked.
Fortune describes the elaborate system of smoke and mirrors that has shaken the world economy. Those who have been reading up on the market meltdowns may recall one further detail: the wizards of Wall Street dubbed these complex financial instruments "insurance."
In the words of the immortal Buck Murdock, irony can be pretty ironic sometimes. Yet the same legal and financial geniuses who have now turned on derivatives are still pushing relentlessly for our insureds to take on an ever-increasing and complex load of liability transfer agreements. The claim is that somehow these agreements make the process safer and more secure for all. What part of "They don’t extinguish risk, they simply transfer it to a different party" did these "experts" miss?
May I suggest a few of the more obvious parallels?
Early financial tools were fairly simple. Bank accounts and simple letters of credit evolved into mortgages, bonds and stocks. Eventually those seemed too dull, so more exotic variations followed, always as "improvements." The most complex derivatives were touted until recently as adding "stability" to the system through ever broader "spread of risk." It worked until somebody realized he had absolutely no clue to what he had agreed, and asked for his money back. Whammo! The emperor was found to have no clothes, everyone panicked, there was literally a run on the bank, and, as Fortune put it, a major counterparty went bust and dragged down others to whom it was linked.
Contractual liability transfers also started fairly simple. For decades, the major exposures were relatively basic business contracts: leases; elevator maintenance agreements; obligations required by a municipal ordinance; sidetrack agreements; and easement agreements. In fact, these were so commonly accepted as normal parts of business that long ago the standard liability forms automatically included them, and hundreds of thousands of insurance students learned them as the aptly titled "incidental contracts."
Then, either through boredom or assumed cleverness, the landscape started seeing more complicated provisions appear. For many years, these new agreements were considered so potentially dangerous that only with specific review and approval by a company underwriter could coverage be created.
Despite the seemingly obvious danger, legal advisors and financial wizards kept pushing the envelope. The simple and obvious agreements of yesteryear have morphed into documents that can be of such complexity and obscure language that even those highly trained to the arts can never be sure they haven’t overlooked some potentially significant detail. Yet they are touted by far too many both in and outside of our business as "standard procedure." Anyone decrying them as over-reaching or simply too obtuse and confusing was labeled as ignorant and obviously unqualified to offer proper advice in this new, sophisticated world.
So "solid and safe" became "old and incompetent." Sound familiar?
As an example of how far we have come from the relatively simplified and accepted hold intended to be covered by standard liability forms, here is the heart of the "blanket" or broad form provision in the ISO CGL definition of "insured contract."
"Insured contract" means f. That part of any other contract or agreement pertaining to your business (including an indemnification of a municipality in connection with work performed for a municipality) under which you assume the tort liability of another party to pay for "bodily injury" or "property damage" to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement.
Now compare what the CGL provides with a real (the names have been changed) hold harmless agreement furnished by Bill Wilson, head of the IIABA Virtual University:
"To the fullest extent permitted by law, ABC Engineering Inc. agrees to defend, indemnify and save harmless XYZ Construction Inc. and Owner, as well as any other parties, which XYZ Construction is required under the Contract Documents to defend, indemnify and hold harmless, and their agents, servants and employees, from and against any claim, cost, expense or liability (including attorneys’ fees), attributable to bodily injury, sickness, disease, or death, or to damage to or destruction of property (including loss of use thereof), caused by, arising out of, resulting from, or occurring in connection with the performance of the work by ABC Engineering Inc., its subcontractors and suppliers, or their agents, servants, or employees, whether or not caused in part by the active or passive negligence or other fault of a party caused by the sole negligence of a party indemnified hereunder. ABC Engineering Inc.’s obligation hereunder shall not be limited by the provisions of any worker’s compensation or similar act. ABC Engineering Inc. hereby agrees that One Hundred Dollars and No/Cents ($100.00) of the Price constitutes the separate consideration for ABC Engineering Inc. indemnity hereunder. Such amount shall be deemed paid out of the first invoice for payment paid hereunder."
If you truly wade deeply into the waters of that language, it just gets uglier. And how far have we gone into the swamps of confusion? Experts at the Virtual University and other services are daily inundated with requests from agents, adjusters and underwriters with two plaintive pleas: (1) tell us just what the insured has agreed to; and (2) does the CGL provide (or can it be endorsed to provide) coverage for all the assumed contractual obligations?
Far too often the only truly honest answers must be (1) "ask a qualified attorney," and (2) "no."
As to (1), in previous articles, I have repeatedly stated I don’t believe agents who are not qualified attorneys should be analyzing and interpreting complex legal agreements. Financial wizard Warren Buffett may have said it best: "Let blockheads read what blockheads wrote."
For those who recoil at the (2) answer, keep in mind the standard liability forms, like our basic financial regulatory system, are designed for the broad spectrum of standard risks and business agreements. Neither was intended to contort itself to include the constantly expanding transfer of risk agreements that have become so complex even those creating them have lost track of the rhyme or reason. And unlike derivatives traded among supposedly competent Wall Street gurus, these agreements in insurance ultimately rest on the backs of the least sophisticated players; smaller insureds who are most likely to either blindly agree, or be bludgeoned into agreeing, to such transfers while simultaneously possessing the least financial ability to fulfill the obligations. Yet proponents strike back at critics with the cry that they are simply spreading the risk more equitably and thus the whole system is safer.
Sound familiar?
Don’t believe them in our industry any more than they should have been believed on Wall Street. Someone has to cry wolf, and who better than that ultimate insured’s trusted advocate, his or her agent? Relentlessly drive home to your clients that the one truth you can verify is what the form says, not what it can be imagined to say. Know exactly what endorsements are available and what each will—or will not—do to address such transfer agreements. It may seem impossible to fight the avalanche, but as far too many know now, it sure would have been nice if a lot more of our financial "advisors" had at least tried.
Because we began by drawing a parallel between the financial investment world and our own, perhaps the last word, when confronting our own complex instruments which "don’t extinguish risk, they simply transfer it to another party," should be given to Mr. Buffett, who sums up some wisdom for us all: "Risk comes from not knowing what you’re doing."