Common law refers to a body of law that has evolved "organically" through the centuries. Various legal cases have come before the courts and the courts have applied and reapplied previous legal precedents to new settings. In this way, common law differs from "statutory law" -- that is, specific laws passed by legislative bodies to address particular situations. English common law -- growing out of the decisions of the English judicial system -- became the basis for law in the English colonies and expanded as our country grew. The legal systems of forty-nine of the fifty states are based, in part, on English common law. (Louisiana, initially a French colony, bases its legal system on the Napoleonic Code -- a statutory system of justice predicated on precepts of Roman law.)
Several important concepts, derived from common law, have an impact on insurers and their agents. Among these are:
Law of Agency
Fiduciary Responsibility, and
Defenses against Liability
The Law of Agency
This legal concept applies when someone (the agent) acts on another's (the principal's) behalf. This concept applies to a wide range of everyday situations -- especially in the business world. For example, trusts and corporation (non-human legal entities) can only act through human intermediaries such as trustees, corporate officers or employees. Insurance companies rely on an outside sales force to market their products, so
the law of agency -- and the salesperson's contract with represented insurers -- determines whether the individual is, in fact, an "agent" of the company.
The question sometimes arises: "To what extent is the principal bound by the agent's actions?". Only authorized acts of the agent can bind the company. So, the answer to that question depends, to a large extent, on the authority the principal confers on the agent. The law of agency recognizes three types of authority that may be given to agents:
Express authority is conferred by a contract. Express authority is given to the agent through his or her contract with the insurer and any amendments made by the company to that contract. The contract explicitly announces the detailed grant of authority to the agent -- and outlines his or her duties. Clearly, if the agent does only what he or she is given express authority to do, those actions would bind the company. As a result of this specificity, few compliance problems arise out of express authority.
Unlike express authority, which is granted via a contract, implied authority comes from the powers that the company customarily gives its agents. For example, an insurer may give an agent the express authority to solicit applications for life insurance on its behalf; by doing so, it also gave the agent the implied authority to telephone prospects on its behalf to arrange sales appointments. Implied authority arises when it:
is intended to be given by the insurer,
usually relates to the general customs of the business,
is not contractually provided, and
is not specifically delineated.
Implied authority can lead to significant liability for insurers, especially if the company knowingly or negligently permitted its agents to engage in unethical sales practices. By the insurer's failure to stop the agents' unethical sales practices, a plaintiff could maintain that the company gave the agents implied authority to act in that fashion. To the extent that the insurer authorized that conduct -- in this case through implied authority -- it is responsible for it just as though it had specified that activity in the agent contract. If the insurer is deemed to have conferred that implied authority, the company could be held liable for any damages resulting from those acts. Implied authority has provided the legal basis for some of the successfully -- maintained lawsuits alleging unethical marketing practices.
Insurers, in order to limit their liability, generally provide considerable direction to their field force as to permitted sales practices and advertising. Although implied authority creates many of the insurer's liability concerns, the type of authority that causes most of the compliance problems is the last type: apparent authority.
The most troublesome level of authority, from the insurer's perspective, is apparent authority. This is authority that a third party, such as a prospective client, can reasonably assume to be given to the agent by the principal. Apparent authority:
is not provided by contract,
is not intended by the insurer, but
appears to the client to be given to the agent based upon the agent's believable statements.
For example, an agent has a rate book and other internal literature from a major insurer and the agent holds himself out to be appointed by the insurer, even though he is not. A prospective client sees this literature and assumes the agent does indeed represent the company. The company can be held liable for the actions of the agent under the guise of apparent authority. Not surprisingly, apparent authority causes a majority of the liability for life insurers.
Even if the agent has none of those three types of authority, it is still possible for an insurer to be liable for the agent's acts. That outcome may result from the insurer's ratification of the agent's acts.
Insurers can, by their actions, confirm or approve of an agent's actions. This confirmation, known as "ratification", can bind the principal (the insurer) to the agent's actions if:
the agent represented himself as an agent acting on behalf of the insurer;
the customer believed the agent's representations;
the insurer subsequently validates the agent's actions by ratifying them in some fashion; and
the insurer ratifies the entire agent transaction.
It should be clear that agent actions may create both personal liability and insurer liability. It is principally the mitigation of that insurer liability that has caused much of the current emphasis that insurance companies have placed on compliance. Despite the fairly clear concepts that may result in liability, the issue of liability is anything but straightforward. In fact, there are a number of other elements that affect liability.
Those who voluntarily agree to act in the capacity of a "caretaker" of another's rights, assets and/or well being are acting in a fiduciary capacity. A fiduciary has an obligation to carry out his or her responsibilities with the utmost degree of "good faith, honesty, integrity, loyalty and undivided service of the beneficiaries' interest." Many times, the fiduciary responsibility is clear cut: a trustee of a trust must manage the trust assets with an eye to the trust beneficiary's best interests. The common law standard applied to fiduciaries is the "prudent man rule". Fiduciaries are supposed to exercise the diligence and foresight that a "prudent" or careful person would under the similar circumstances. In many jurisdictions, the common law standard has given way to new, statutory regulations governing a fiduciary's responsibilities -- commingling of assets, proper investment standards, etc. But whether the standard is the old common law "prudent man rule" or a series of statutory obligations, the underlying premise is the same: The fiduciary must place the interest of others above his or her personal interests.
Insurance agents who solicit applications and collect premium monies on behalf of insurance companies clearly have a fiduciary responsibility to the company. Insurance agents owe their primary allegiance to the company that appointed them.
But agents also have a responsibility to their clients. As the Florida Attorney General states: "Licensed insurance agents and representatives place themselves in a position of fiduciary duty to the consumers who enter their business looking for guidance in their insurance purchase".
These conflicting duties -- to the insurer that appointed them and to the customers who rely upon them -- pose a real dilemma for insurance agents. The solution to this conflict is honest dealing with all parties and full disclosure, or at a minimum, disclosure of the conflicting duties.
Defenses Against Liability
While the Law of Agency and Fiduciary Responsibility impose obligations on the agent, there are several common law concepts that can act to mitigate the agent's or insurer's liability: waiver, estoppel, election and "course of conduct and custom".
The Course of Conduct and Custom Doctrine considers how parties to a transaction have conducted themselves in the past. The premise being that if the parties handled their affairs in a particular manner for a long period of time, it is not unreasonable to conclude that such actions were acceptable to both parties. Suppose, for example, a client purchases annually renewable term life insurance policy from an agent. The agent never sent a notice of expiration to the client, yet year after year, the client would contact the agent to renew the coverage. The coverage remained in force for twenty years, after which, the client did not contact the agent. The policy lapses, and a short time thereafter the inevitable occurs -- the insured dies. The beneficiaries are at a loss to explain why there is no death benefit forthcoming from the insurer. The beneficiaries sue the company and the agent alleging that the agent had a duty to inform the client of the expiring coverage. Under the common law doctrine of "Course of Conduct and Custom" the court would review the facts in light of how the parties behaved in the past. Since it was not customary for the agent to send a notice of expiration -- and the client operated under those circumstances for twenty years -- the court could decide that the agent does not have a duty to inform.
Another defense against liability is a waiver. In a waiver, an individual voluntarily and intentionally give up of a right the individual knows he or she has. Once waived, the individual cannot reassert that right. For example, a client signs an absolute assignment, in effect transferring a life insurance policy to someone else. By doing so, the client is aware that she will give up control over the policy to the assignee. By assigning the policy, she has waived her rights under the policy and cannot claim at a later date that she continues to have them.
A related concept is that of estoppel. For example, a health insurance policy states that if the policy lapses and the policyholder wishes to reinstate the policy, all delinquent premiums must be sent directly to the home office. Assume that the policy lapses and the policyholder drops off the premiums at the agent's office -- who forwards them to the insurer, which then reinstates the policy. A couple of months later the insured is injured in an accident. The insurer cannot now claim that the policy is not in force because the premiums were not paid directly to the home office, as required in the policy documents. The insurer is said to be "estopped" from asserting the policy's written provisions due to its action of reinstating the policy. (By accepting the payments via the agent, it "waived" its right to a home office payment -- and is "estopped" from using that as an excuse to not pay the claim.)
The last defense we noted is called election. The concept works in the following fashion. When a party to an insurance contract has a choice of actions and chooses one, he cannot subsequently change his choice if the change would be detrimental to the other party. If a client agrees to repairs of damaged property but later attempts to change the choice to a cash settlement after repairs are started, the court might say that the client had elected the repair option, and he would be held to that position. To do otherwise would injure the other party -- the insurance company.