The application process is undertaken by an organisation and its management to establish insurance coverage. The process itself is somewhat different from what is usually the case for other classes of insurance. Nevertheless, it is essential to understand in order to achieve the best possible terms – while also minimising any frustration.
In this article, we will explore the application process within the context of the following coverages:
- Directors and officers liability insurance
- Employment practices liability insurance
- Management liability insurance
- D&O insurance for nonprofits
You may also find that similar concepts apply to a broad range of financial lines insurances, such as professional indemnity insurance, cyber insurance, and even crime insurance to a certain extent. Keep in mind, however, that each policy is strictly interpreted according to its own terms and conditions.
Application process: A definition
The application process describes what an organisation must undertake to acquire insurance coverage. As a contract between two parties – an insurer and an insured – the establishment of a policy requires an offer and acceptance of terms. For an organisation, this means that it will need to follow a specific process in order to receive an offer for the terms its desires.
Preparing a submission is the first step in acquiring coverage. To do this, an organisation is required to work closely with its broker to collect relevant information about its operations. In turn, this information is presented to an insurer for consideration, so it can decide on whether it will offer coverage, and if so, on what terms.
The application process is important because it forms the basis of what types of loss will be covered, and the quality of that coverage. Generally speaking, the more accurate the information provided, the more comfortable an insurer will become with the risk. Done well, an organisation may be able to acquire more favourable terms than would otherwise be possible.
The components of a submission
A submission describes a collection of information that an organisation presents to an insurer. It should include most, if not all, of the following elements.
An organisation is required to complete a proposal form as part of the application process. A proposal form is a formal declaration about an organisation and the risk it is exposed to.
The type of information found in a proposal form includes:
- The name of the organisation to be insured
- Its business activities and industry
- Its annual revenue and balance sheet position
- The geographic location of its operations
- The number of its employees
- Information relating to its control environment
- Its loss history, including the details of any recent claim notification
Ideally, an organisation should complete the proposal form of the insurer it is seeking coverage from. This will aid an insurer with identifying particular information that it would like to know. That said, one insurer may accept the proposal form of another as a courtesy – but any quotation released may be subject to receipt of additional information, or the completion of its preferred proposal form.
A range of supporting documents can be provided to an insurer to help it understand the risk better.
Common examples of supporting documents include:
- Additional information about an organisation, its management, and business activities
- A supplementary proposal form
- A copy of relevant policies and procedures
- A copy of an external audit of the control environment
- A detailed description of any claim settlement
Supporting documents should be provided if they will be useful to an insurer when making a decision. Special care should be taken to keep it relevant – as too much unnecessary information can be overwhelming and counterproductive. The balance of additional information will depend on the class of insurance, the complexity of the risk, and the insurer involved.
The most recent financial statements allow an insurer to make an assessment of an organisation’s financial position. If an annual report is available, this should be provided as well.
Financial statements generally include the following components:
- Balance sheet
- Profit and loss statement
- Cash flow statement
Ideally, financial statements should be audited, or third-party prepared at the very least. An internal accounting report is generally not sufficient because it is difficult to determine its integrity. For larger and more complex organisations, financial statements will be mandatory. However, for small and medium enterprises, there may be some flexibility on this requirement.
Ownership structure diagram
An ownership structure chart will allow an insurer to better understand an organisation when it consists of a group of entities. Additionally, it is also a helpful exercise for an organisation and its broker. By reviewing the relationship between entities, it is possible to overlay this with how a policy structures coverage for a principal insured organisation, an additional insured organisation, and any subsidiary.
Satisfying a duty of disclosure
An organisation has a duty of disclosure to declare all material information about itself to an insurer. An insurer relies on this information to make a decision about whether to offer coverage – and if so on what terms. For this reason, it is important that the information is a true and accurate representation of the underlying risk.
The basis of this duty rests upon a key principle of insurance contract law, the doctrine of uberrima fides – a latin phrase meaning utmost good faith. Acting with good faith means that both parties to a contract – an insurer and an organisation – are under a strict duty to deal fully and frankly with each other – disclosing any material fact, as they negotiate its terms.
A material fact is considered to be any piece of information that an insurer could reasonably rely on when deciding whether or not to accept the risk of an organisation. This information is collected in various ways, and aims to cover all aspects of what an insurer needs to know during underwriting – from its business activities and geographical exposure, to risk management and loss history.
The role of an application in the policy lifecycle
The application process occurs at the beginning of a policy’s lifecycle. However, it is not the only time where an organisation will need to disclose important information to an insurer.
Application and submission
During the application process, an organisation is required to make a submission to an insurer, which includes a proposal form. A proposal form will usually contain a no known claims letter built-into the declarations page. By signing this document an organisation confirms its compliance with the duty of disclosure, and this agreement forms the basis of the policy.
Underwriting, quoting and binding
An insurer will complete its underwriting process using the information contained within the submission. Once a quote is issued, it will typically remain valid for 30 days – subject to there being no material change to the underlying risk. If the quote is allowed to expire, the proposal form will need to be resigned and redated before coverage can be bound.
Once a policy in place, its terms will be set for the duration of the policy period. If an organisation would like to make changes to its coverage mid-term, this will need to be completed by endorsement.
Common examples of a mid-term adjustment include:
- Increasing the limit of liability
- Including an additional insured organisation
- Expanding the jurisdictional limits or territorial limits
- Amending the expiry date
- Proceeding with an extended reporting period following a change in control
An insurer may be somewhat wary of unusual requests for changes to coverage mid-term – and rightfully so. A policy’s prior acts coverage can expose an insurer to undisclosed claims if changes are not carefully considered. As a result, any alterations to the risk will need to be underwritten, and a signed no known loss letter will be required before changes are confirmed.
Expiry and replacement
As the policy period comes to an end, a replacement policy will need to be arranged. In most circumstances, an organisation will need to complete a new proposal form and provide its latest financial statements. Sometimes, a fast-track replacement process may be available – requiring less documentation. However, this is typically reserved for small and medium enterprises and nonprofit organisations.
Who can represent an organisation
An insurer reserves the right to determine who within an organisation has the authority to make representations on its behalf – and have it be accepted as a basis for coverage. This requirement will typically be defined in the declaration section of a proposal form and no known loss letter.
Representations are typically accepted from the following persons:
- Chairman of the board
- Managing director
- Chief executive officer
By restricting who can make representations on behalf of an organisation, an insurer aims to reduce the chances of material misrepresentation and moral hazard more generally. If a declaration is not signed by one of these persons, an insurer is not likely to accept whatever alternative is provided. And if not rectified promptly, it can place an organisation’s coverage in jeopardy.
Imputation and severability of knowledge
When it comes to issues surrounding non-disclosure, a policy will describe how information will be imputed and severed between an organisation and its management.
Imputation of knowledge onto the entity
There will be certain senior managers within an organisation – such as the chief executive officer, chief financial officer, and chief operating officer – who will have their knowledge imputed onto an organisation. This means that any non-disclosure by them will have a material effect on the coverage of an entire organisation, not just their own.
Severability of knowledge between individuals
A policy is also likely to address the severability of information between individuals. Often, with respect to non-disclosure, the knowledge of one individual will not be imputed onto another. This means that one person’s non-disclosure will only affect themselves, and not an innocent person – with the exception of those whose knowledge is imputed onto an organisation.
The importance of checking policy documents
It is important to maintain attention to detail throughout the application process. An insurer is likely to offer any terms in line with its underwriting strategy, and this will often vary substantially from the coverage requested. Even when replacing a policy, a holding insurer generally reserves the right to alter its terms (often significantly) from one year to the next.
When policy documents are eventually issued, it is important to carefully check the schedule, wording, and endorsements, to ensure that they accurately reflect the terms as bound. In the event of a claim, it will be the policy that is referenced, not the quotation. Therefore, it is important to have any discrepancies rectified as soon as they are identified.
If at any time there is uncertainly about the intent of a particular clause or endorsement, clarification should be sought from the insurer. For example, who has the duty to defend? While an insurer will be careful not to prejudice the language of the policy, the subsequent discussion will be helpful for minimising any divergence of expectations.
Application process: An example
Now that we have explored the application process and the influencing factors, we can tie it all together.
An organisation wishes to purchases an insurance policy to protect its management from board of directors liability. It is seeking a policy period of twelve months, from 31 December this year to 31 December next year. Its desired limit of liability is $1 million any one loss and in the aggregate, with a self-insured retention of $5,000 for Side B coverage, defence costs inclusive.
The organisation has been operating for many years in the entertainment industry. Its chief executive officer completes a proposal form and submits this to his broker – along with the organisation’s most recent financial statements and an ownership structure diagram. No claims or circumstances have been disclosed on the proposal form.
The broker provides the submission to an insurer. Following a review of the organisation’s activities, the insurer is of the opinion that a more suitable self-insured retention is $10,000. A quote is issued with the desired limit of liability for an annual premium of $5,000. After a few days of consideration, coverage is bound and policy documents are issued.
The application process is undertaken by an organisation and its management to establish insurance coverage. The process itself is somewhat different from what is usually the case for other classes of insurance. Nevertheless, to achieve the best terms possible, it is essential to understand. It will also minimise any frustration.