By Todd Piersol, Executive Vice President, Brown & Brown of Detroit
A couple years ago I posted a an article called Contract or Commodity: https://bbtex.wpengine.com/contract-or-commodity/ , which made the argument that insurance policies should be given more attention as being true contracts versus a commoditized expense. While my career as an insurance topic journalist may not be relevant, the topic of insurance contract commoditization remains such. Thus, I present to you, my cherished audience of at least three, Contract or Commodity – The Sequel (or Part Deux, for you Tiger Blood fans). Unlike most sequels, this one is sure to be a crowd pleaser.
Act 1: The Setup
Business owners and their appointed advisors review contracts on a regular basis. It’s important, particularly in a litigious society (that’s the part of the sequel that makes reference to a point made in the original article – for true fans). A part of this focus on contracts is an awareness of major shifts in legislation and acceptable business practices, to try and leverage these changes to the maximum benefit possible. The point is to try and build the best contract possible, one that is palatable to the other party while providing the most flexibility and leverage to the business owner. Commercial real estate, for example, a business dynamic that impacts many businesses to a large degree, is filled with contract provisions in leases and in lending. For example:
Due-on-Sale Clauses: “Due-on-sale” clauses provide that the loan will be immediately payable in full if the real estate is sold without the lender’s consent. These clauses are often drafted extremely broadly and also prohibit transfer of any interest equity in the borrower. However, they can be modified or excepted in certain cases, which provides great flexibility to the borrower/business owner.
Secondary Financing: Most commercial loans prohibit the borrower from placing a second priority lien on the property. This provision, coupled with a prepayment penalty, may preclude a borrower from tapping into equity in the property for a number of years. Again, with the right consultation, these provisions can be eliminated or altered to include mezzanine loans.
Notice and Cure for Default: In addition to making timely payments on the loan, loan documentation imposes myriads of obligations on a borrower, from the timely payment of taxes to proper maintenance of the property. A borrower should negotiate for a provision in the loan documents that requires the lender to give notice and a reasonable opportunity to cure an alleged default (assuming the default is curable) before the lender declares the loan to be in default.
Initial contract offerings generally benefit the issuer of the contract the most. Business owners are generally ecstatic to learn that their real estate advisor has effectively negotiated the best terms in clauses such as those listed above. Here’s the ironic part of that: the business owners have a low probability of ever using these clauses, yet they are happy they are written to their advantage due to the possibility they will be needed. If they are needed, the right language could save them hundreds of thousands, even millions, of dollars in legal disputes and penalties. It is worth the attention.
Act II: Plot Development
On one corner of the business owner’s desk sits their executed commercial lease and loan documents, containing advantageous clauses they never fully expect to use. The stack of papers logs in at 123 pages (must be important!). Behind the desk, on a bookshelf that holds an HR manual from 2002, QuickBooks for Dummies (from before they could afford an accountant), sit five three-ring binders that say “Insurance” down the spine. Inside those insurance binders are page after page of insurance jargon. You know, “definitions,” party responsibilities, exclusions, and other contract clauses. We’ll get back to this.
Every year, the business owner has an opportunity to review the contract and strengthen the terms, really nail down the best contract language to give them every benefit in the event of the “improbable” catastrophic claim, which could save them hundreds of thousands, even millions, of dollars in legal disputes and uncovered claims. Yet, how does the renewal process with their appointed insurance advisor generally proceed? A review of what is covered (plant, property, equipment, payroll, liabilities, etc.), maybe a cursory look at exclusions and enhancements, followed by a premium summary. Frankly, that renewal would be more involved than many that actually just review premium.
Why not look through the entire contract? Do the business owner and insurance advisor really trust the insurance company so much that they assume the initial contract offering is completely equitable? I’m here to tell you what you already know: the insurance company is a business too, they have enlightened self-interest, and they should. They will first put in front of you the version of a contract that is best suited to give them flexibility. If you buy it, don’t blame them!
Act III: Making it Stick
So what clauses in an insurance contract might make a difference, like the previously mentioned real estate provisions? Here are a few:
Notice & Knowledge: This defines the insured’s responsibilities in the event they gain knowledge of a claim or incident that might give rise to a claim. The insured wants what constitutes “knowledge” to be as narrowly defined as possible (e.g. – when the CEO knows about it).
Definition of Bodily Injury: How is mental anguish covered, or is it at all? If someone slips and falls on your premises, is mental anguish covered if it results from bodily injury? Is it covered even if they aren’t physically injured? Is it not covered at all?
Hammer Clause: What happens when the party suing you for liability, let’s say wrongful termination, is willing to accept a settlement, and the insurance carrier is willing to pay, but you are unwilling to give in? Are you now on the hook for the bulk of any additional costs or judgements?
Initial contract offerings generally benefit the issuer of the contract the most (recognize this sentence?). Business owners are generally ecstatic to learn that their real estate advisor has effectively negotiated the best terms in clauses, but rarely even ask if their insurance advisor tried. Here’s the ironic part of that: the business owners have a low probability of ever using the clauses in either contracts, yet there is a possibility they will be needed. If they are needed, the right language could save them hundreds of thousands, even millions, of dollars in legal disputes and penalties. It is worth the attention.
Act IV: Closing
In the end, business owners everywhere take interest in the 123 page insurance binders, challenge their insurance advisors to explain the contract language and negotiate the best terms possible (or find an advisor who can and will), the prince marries the princess, evil is thwarted, the character who was so awkward and angry early turns out to be a kind-hearted savior, the underdog makes a surprising last minute comeback to win, people laugh, people cry, but everyone sleeps easy knowing they have the best insurance contracts available.