October 1998 Issue


By Douglas R. Shaller

PAs, financial advisors, and risk managers should have a basic understanding of the market for employment practices liability (EPL) insurance. The key is being able to judge whether the benefits of EPL insurance are greater than the costs for a specific employer.

From my experience working with a broad cross-section of employers on preventative measures, I have found that five simple but fundamental principles of EPL will identify employers with the greatest need for prevention and for EPL insurance.

Follow the Money

An analysis of claims paid on employment disputes will reveal which risks are the most significant. Although there are a mind-numbing number of possible charges in any employment-related lawsuit, such as implied contract claims and common law torts, the real money is awarded because of statutory claims.

Statutory claims are employment-related lawsuits claiming a violation of Federal statutes such as Title VII of the Civil Rights Acts, the Americans With Disabilities Act, the Age Discrimination in Employment Act, and corresponding state fair employment statutes. Typical statutory discrimination and harassment lawsuits are based on claims that termination of employment or some other adverse employment action was based on physical or mental disability, age over 40, ancestry, color, national origin, religion, race, or sex.

The class of employment-related lawsuits that cost employers the most money are statutory claims caused by the actions of relatively inexperienced supervisors. If a lawsuit goes to trial, the typical minimum cost to the employer is $100,000 for attorney and expert fees. A sexual harassment lawsuit with allegations of retaliation can easily cost upwards of $250,000 to defend if it goes to trial. If the employer is found liable, damage awards can range from $20,000 to millions of dollars. Damage awards are highly unpredictable, in part because most cases involve the evaluation of a great deal of seemingly contradictory evidence and because decisions are rendered by juries of the plaintiff's peers. If you add in the value of senior management time spent in depositions and other litigation tasks and other disruptions and loss of privacy, the true economic costs can be astronomical. As a consequence, employers find it cost-effective to settle most cases, even those that could be won in court. Very few cases go to trial.

Look for the Holes in Coverage

Employers without EPL insurance can sometimes get coverage for employment-related risks from their other general business policies such as commercial general liability (CGL), employer liability (EL), errors and omissions (E&O), directors and officers (D&O), or umbrella policies. The opportunity in these policies is usually the coverage for bodily injury or personal injury. Claims of emotional and/or physical injury have been used to get insurers to pay the entire defense in complex employment-related lawsuits.

Insurers may have to pay all the defense costs because, under insurance law, the insurance company has a broad duty to defend the entire lawsuit when there is a possibility that even one of the myriad charges might be covered by its policy. For example, President Clinton's personal liability umbrella insurers paid out $1.5 million for his defense of sexual harassment charges brought by Paula Jones because of the potential personal injury due to defamation of character. Nevertheless, coverage has become much harder to get under recently written conventional commercial policies because of exclusions.

The role of EPL insurance is to fill in the holes in coverage caused by employment, employment-related, and other exclusions in conventional insurance policies. In fact, an employer's need for EPL insurance will depend upon the employment-related exclusions written into the employer's insurance policies.

Consider CGL Insurance. Commercial general liability insurance is usually the employer's most important source of insurance coverage. The most relevant CGL exclusions from coverage are expected or intended injuries arising out of and in the course of employment, willfulness, and certain blanket employment-related practices exclusions. With a CGL policy in force that has all these exclusions there might be a duty to defend the employer, but only in a minority of cases.

The main point here is that it is becoming increasingly difficult to obtain coverage under recently written policies because of their exclusions. Also, most insurers have become less willing to pay for employment-related defense costs based on conventional policies without putting up a fight.


From the employer's point of view, the most important characteristic of the EPL products on the market is that they cover attorney and expert fees and other defense costs. While the products vary in detail, all require some preventative measures, all exclude most fines and penalties, and most exclude punitive damages (punitive damage awards are illegal in a number of states and will not be paid). Coverage is either stand alone, or add-on, and the distinction can be important in terms of the cumulative limits and breadth. For example, in a D&O rider, the company would not normally be covered although the officers and directors would. Also, insurers have begun to include risk management services. Risk management services programs currently being offered are not that well developed, but this will change in the future as the products mature.

Follow the Risks

A method used in determining whether an employer needs EPL insurance is to follow the risks. Those that most need EPL insurance will have the highest risks coupled with a relatively low ability to self-insure.

High-risk employers include all employers who are perceived as possessing "deep pockets" such as the following:

* Employers with wealthy or well-known owners

* Franchisees of national franchises

* Venture capital­backed employers

* Employers in trendy industries

Employers who "should have known better" are punished by juries and therefore have to pay more to settle cases and are sued more often. Should-have-known-better employers include--

* lawyers,

* not-for-profit organizations,

* health-care institutions, and

* governments.

In general, anytime there is a high degree of separation of ownership and control due to absentee owners or other lack of direct ownership control there is greater risk.

How do you spot such high-risk employers? By asking some pointed questions and looking around! The telltale signs of the high-risk employer include the following:

* Relatively high workers' compensation costs

* A culture of undocumented unsatisfactory employee performance

* Recent or projected widespread

* Rapid growth

* Relatively inexperienced employees with supervisory responsibility

* A culture of rising expectations

Can the Employer Afford to
Retain the Risk?

Keep in mind that the main reason an employer needs insurance is to protect against low-probability risks that have disastrous consequences. The first step in evaluating a need for coverage is an employment risk audit. The second step is proactive risk control through the adoption of preventative measures including appropriate written policies and procedures, mandatory dispute resolution policies and procedures, and systematic written documentation of performance problems. The third step is training for all supervisors, especially those with less experience or newly promoted to a supervisory position. But even an employer who diligently takes all three steps might still experience disastrous lawsuits. Thus, there may be a need for EPL insurance to cover the residual risks for many high-risk employers, including those who practice good loss control. The five fundamental principles of employment practices liability should help to identify which employers can benefit from EPL insurance. *

Douglas R. Shaller, PhD, CPA, is the founder of Employment Practices, Inc. (EPI) in Newton, Mass. EPI develops employment risk audit and control systems for employment practices liability. He can be reached at (617) 244-0172 or via e-mail at doug@epi-inc.com.

James L. Craig, Jr., CPA
The CPA Journal

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