By Steven H. Weisman and Anne Matthews, Attorneys, McCarter & English, LLP
There is an inherent conflict of interest created by retrospective premium policies not present in the more typical, guaranteed cost policy. In a guaranteed cost policy, the parties' interests are generally aligned. The policyholder pays premium based on exposure estimates, which may be subject to premium audit based on changes to payroll or sales, but cannot be adjusted up or down based on any difference between the estimated and actual defense and indemnity costs paid under the policy. By contrast, the initial premium paid under a retrospective policy is subject to adjustment based on actual loss experience during the policy period and defense and indemnity costs are thereby "passed through" to the policyholder. Because of this "pass through" structure, insurers lack incentive to handle claims in a cost-effective manner under retrospective premium policies.
Many courts have recognized this inherent conflict of interest, noting the problem created when an insurer, which is essentially using its policyholder's money, unconditionally assumes the right and duty to defend, taking control of those costs out of the policyholder's hands. Courts have responded by placing a burden on insurers to prove that the claims handling practices giving rise to retrospective premium charges are reasonable and made in good faith. A few courts have gone so far as to impose a fiduciary duty on insurers with respect to claims handling practices under retrospective policies. These heightened risks and responsibilities for policyholders and insurers, respectively, suggest parties to such retrospective premium policies should take steps to ensure increased claims handing oversight and documentation.
Steven H. Weisman is a Partner, and Anne Matthews is an Associate with McCarter & English, LLP's Insurance Coverage & General Litigation Group. Mr. Weisman and Ms. Matthews counsel policyholders on a wide range of insurance coverage issues and premium disputes.
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