Why insurance won't pay non-monetary claims
By Kevin C. Murphy,
CPCU, ARM, AU
"We will pay those sums the insured becomes legally obligated to pay as damages" is as familiar an opening line to insurance professionals, as "When in the course of human events" is to students of American government.
The former is, with only minor variation, the opening statement in the coverage agreement of most liability insurance policies. The intent of everything else that follows through the many pages of a policy is to clarify the obligation of an insurer to assume the financial loss of an insured resulting from accidental losses.
Land use issues
More and more often, however, municipalities are confronted with land use and growth issues that require attention to risk management, but which fall outside the realm of insurance.
For example, a zoning board of appeals denies a rezoning request from a new owner of a parcel of land because it believes the owner's intended development would be detrimental to the community. The landowner may file a lawsuit that simply seeks to overturn the decision, rather than seeking monetary damages.
Insurance is purchased to protect against financial loss. If there is no risk of financial loss to the insured due to a lawsuit, it is rare to find an insurance policy that will respond.
What about legal fees?
Some municipalities argue that if a third party files a claim or lawsuit against them, the legal fees the municipality incurs to defend the legal proceeding is a financial loss that should be insured. This seems like a reasonable argument on the part of the insured. So, why won't a municipal insurer assume these costs?
Once an insurer sets a precedent of assuming the legal costs of the insured in an effort to avoid a claim for monetary damages, uncertainty will develop as to what other legal costs the insurer will eventually be asked to assume.
For example, most municipal governing boards employ or contract with a municipal attorney who will attend meetings and render advice on issues ranging from parliamentary procedure on up the scale. It could be argued that the primary reason legal counsel attends meetings is to guide the council through difficult proceedings and to lessen the likelihood that council makes a poor decision, leading to a lawsuit. For this reason, why wouldn't the insurer pay the cost of the municipal attorney? Isn't it better to pay a little now to avoid a potentially big claim later on?
Reasonably, it may seem so. But insurers can make actuarial projections within an acceptable range to predict the likelihood of their future claim payments. Adding in the cost of paying legal fees for claims that aren't covered by insurance, or in an attempt to avoid future claims, does not significantly reduce the actuarial estimate of future claims. It would, however, significantly add to the cost of insurance. This cost would be passed on to you through higher premiums.
Pay to fix the problem or defend and pay the claims?
Another example is a municipality's exposure to sewer backup. It may seem reasonable for an insurer to help a municipality financially to correct an inadequate sewer system, rather than to continue defending and paying claims.
Again, though, the purpose of insurance is to pay the legally obligated claims of the insured, not to assume the administrative or maintenance costs of any one person or organization.
Insurance vs. risk management
All of this leads to an understanding of the difference between insurance and risk management.
Risk management is a specialty within the broader function of management. It involves planning, organizing, leading and controlling the activities of an organization in order to minimize the adverse effects of accidental losses.
Purchasing insurance is probably the most recognizable risk management method a municipality will practice. But there are other procedures your municipality should recognize that do not involve the transfer of your risk of loss to an insurer.
I have already mentioned using a municipal attorney. A governing body that relies on an objective municipal law expert for advice and recommendation is practicing excellent risk management.
A municipality that develops and implements financial models, master plans and other long-term planning tools is taking a proactive approach to risk management. Relying only on insurance to protect your municipality from loss is entirely reactive.
Municipalities that invest in improving their local infrastructure are practicing excellent risk management. The loss control professionals your insurer employs can be a valuable resource in helping you recognize your loss exposures, and in suggesting appropriate remedies. This will help you set priorities for infrastructure improvements.
The cost of municipal insurance should not be your complete risk management budget. Insurance involves deductibles, exclusions and valuation clauses that must be considered within the broader scope of risk management.
Anticipate how much your municipality will pay for claims that involve a deductible. Estimate the likelihood that you will assume the legal costs of a claim alleging non-monetary damages. When you include an estimate of these costs in your annual insurance or risk management budget, you will be much less likely to be surprised by an insurance exclusion or coverage limitation during the year.
When you add up the cost of your annual investment in legal counsel, infrastructure upgrades and other management techniques, it becomes clear that insurance is only one aspect of the risk management function.
Kevin Murphy, CPCU, ARM, AU, is associate director of the Michigan Municipal League and directs the League’s Risk Management Services.
© 2003 Michigan Municipal League