In July 2018, The Orange County Bar Association published an article written by Robert J. McKennon and Stephanie L. Talavera of the McKennon Law Group PC in the Orange County Lawyer.  The article addresses the liability implications of the relationship between insurers and various types of intermediaries.  As the article explains, depending on the nature of the relationship between the insurer and others involved in the process, the insurer may be held liable for the actions of those who act as its intermediaries.  The article gives tips on how to make an insurer vicariously liable for the acts of those functioning as intermediaries in the insurance process.

Insurers’ Intermediaries: The Implications of Actions Taken by Agents, Employers and Third-Party Administrators[1]

By Robert J. McKennon & Stephanie L. Talavera[2]

Those engaged in the business of insurance often act through intermediaries: agents, brokers, third-party administrators (“TPAs”) and employers.  For example, an appointed insurance agent may sell an insurance policy and a TPA might handle the policyholder’s claim for benefits.  In the context of employer-sponsored, group insurance plans, an employer may act on behalf of an insurer in collecting premiums via payroll deductions or investigating eligibility, temporarily transmuting the employer-employee relationship.  Occasionally, the employer may, itself, act as the insurer, providing benefits through a self-funded plan (typically with the help of a TPA).  It goes without saying that how an intermediary relates to each party imports different contours of liability.  In this article, we explore some of those theories as they relate to insurance agents, brokers, TPAs and employers, as a good insurance litigator must be able to use all available theories of liability.

Agents of the Insurer

In assessing an insurer’s liability, or an employer stepping into the role of an insurer, it is critical to first identify the various parties involved in the insurance procurement and claims process.  Once identified, you must determine when each party acts on behalf of the insurer, so as to render the insurer vicariously liable for the actions of its agents.  The most important parties to the insurance procurement and claims process are discussed below, and at least include insurance agents, insurance brokers, TPAs and employers.

 Insurance Agents vs. Brokers

Courts sometimes use “agent” and “broker” interchangeably.  This inconsistent usage confuses terminology that already relies on an unpredictable, independent factual examination of the relationship on a case-by-case basis.  But, the primary distinction between an insurance agent and broker is who each represents.

An “insurance agent” is “a person authorized, by and on behalf of an insurer, to transact all classes of insurance other than life insurance.”  Cal. Ins. Code § 31.  A life agent is a person authorized by and on behalf of a life, disability, or life and disability insurance company to transact life and disability insurance.  Cal. Ins. Code §§ 32, 1622.  An appointed life insurance agent is always at least the agent of the insurer.  See Loehr v. Great Republic Ins. Co., 226 Cal.App.3d 727 (1995).  “The most definitive characteristic of an insurance agent is his ability to bind his principal, the insurer.”  Marsh & McLennan v. City of Los Angeles, 62 Cal.App.3d 108, 117 (1976).  An agent may bind the insurer by “acts, agreements, or representations within the ordinary scope and limits of the insurance business entrusted to him … even if the agent’s actions violate private restrictions on his or her authority.”  Troost v. Estate of DeBoer, 155 Cal.App.3d 289, 298 (1984).

In contrast, “‘[i]nsurance broker’ means a person who, for compensation and on behalf of another person, transacts insurance other than life, disability, or health with, but not on behalf of, an insurer.”  Cal. Ins. Code § 33; Krumme v. Mercury Ins. Co., 123 Cal.App.4th 924, 929 (2004).  Brokers represent potential insureds or policyholders in purchasing insurance and typically act independently, working with several insurance companies.  Id. at 929.  Thus, a broker acts only on behalf of the client, the potential insured or policyholder, and not the insurer.  Carlton v. St. Paul Mercury Ins. Co., 30 Cal.App.4th 1450, 1457 (1994).

Employers

Much of the insurance in force in the United States is placed through employers in the form of employee benefits, such as long-term disability insurance, short-term disability insurance, life insurance and health insurance.  Employers play a vital role as plan sponsors and plan administrators of these group insurance policies, and are often responsible for enrolling new members, collecting premium contributions via payroll deductions and submitting claims for policy benefits on behalf of the insurer.

Although the Employee Retirement Income Security Act of 1974 (“ERISA”) governs many of these employer-sponsored plans, occasionally, employers “self-fund” such plans and qualify for an exemption from ERISA on that basis.  When a plan is self-funded, the employer steps into the role of the insurer.  Because the employer is not routinely engaged in the business of insurance, it may hire a TPA to handle the group policy’s administration.  Under this arrangement, an employer begins to look even more like an insurer, using a TPA’s insurance expertise while retaining the benefits of having a self-funded plan.

TPAs

Sometimes referred to as the “downstream” intermediaries, TPAs play an important, but different, role in the insurance process.  TPAs handle the rote tasks that keep the insurance industry moving, such as recordkeeping, policy administration, underwriting, investigating and claims handling.  TPAs are not typically involved with individual policies, but increasingly play a key role in employer-sponsored group policies, where they assist employers in all aspects of plan administration.

Insurers’ Vicarious Liability Based on Actions of Insurance Agents, Employers and TPAs

The most complicated of the third-party relationships is the agent vs. broker distinction, which becomes particularly important concerning which actions will be imputed to the insurer.  Generally, an agent’s actions are imputed to the insurer, but a broker’s do not, and only the former renders the insurer vicariously liable.  See LA Sound USA, Inc. v. St. Paul Fire & Marine Ins. Co., 156 Cal.App.4th 1259 (2007).  This distinction is often important in insurer rescission matters, based on an alleged misrepresentation in an application for the insurance policy.  Frequently, a potential insured will make accurate disclosures to the agent or broker as part of the application process, but the agent or broker will tell the potential insured that such disclosure on the application is unnecessary.  Depending on whether the agent is treated as an agent of the insurer or an agent of the insured (a broker), knowledge of the misrepresentation, and consequent liability, will be imputed differently.  If an agent is responsible for the alleged material misrepresentation, the insured may argue that the insurer is responsible for the misrepresentation and thus cannot rescind the policy regardless of whether the disclosure was actually communicated to the insurer.  See e.g., O’Riordan v. Federal Kemper Life Assur., 36 Cal.4th 281 (2005) (imputing agent’s knowledge despite agent’s failure to actually communicate insured’s history of smoking).

Like insurance agents, traditional theories of agency and contractual privity immunize TPAs from independent liability for their claims handling misconduct.[3]  TPAs act as the principal’s disclosed agents and lack contractual relationships with the insureds.  So, a TPA is not typically liable for its bad faith claims handling conduct, even if its sole responsibility is to handle claims.  See Gruenberg v. Aetna Ins. Co., 9 Cal.3d 566, 576 (1973).

When it comes to group policies, California law treats employers as agents of the insurer.  The rationale behind this application of liability is that when an employer administers an insurance policy on behalf of the insurer, it acts as its TPA and thus its agent.  Accordingly, an employer’s conduct is attributable to the insurer.  See McCormick v. Sentinel Life Ins. Co., 153 Cal.App.3d 1030 (1984); Elfstrom v. New York Life Ins. Co., 67 Cal.2d 503 (1967).  But, as noted above, ERISA governs many group policies offered through employer-sponsored plans and consequently, preempts state laws that would otherwise determine the agent relationship and vicarious liability.  See UNUM Life Ins. Co. of Am. v. Ward, 526 U.S. 358 (1999).  For some time, the question remained as to whether employers also acted as agents of the insurer when administering a group policy governed by ERISA.  Recently, in Salyers v. Metro. Life Ins. Co., 871 F.3d 934 (9th Cir. 2017), the Ninth Circuit squarely addressed this issue, ultimately applying California’s rule on employers as agents.  As a result, when employers collect premiums, enroll individual plan members and otherwise administer claims, they act as agents of the insurer.  Accordingly, the knowledge and conduct of the employer may be imputed to the insurer, even if it was not communicated to the insurer directly.

Employers Treated as Insurers

In some situations, there may not be an insurance company involved in the traditional sense.  Instead, an employer or some other entity not typically engaged in the business of insurance may act as the functional equivalent of an insurer.  This may arise when an employer self-funds or self-insures a group policy covering its employees that qualifies for an exemption under ERISA.  Whether the entity is acting as an “insurer” is important because the special relationship involved in an insurance contract may give rise to a cause of action for insurance bad faith–allowing the individual to pursue extra-contractual recovery against the employer, such as emotional distress damages, attorney’s fees and punitive damages.

Although ERISA traditionally preempts state law causes of action for breach of contract and insurance bad faith, when the group policy is exempt from ERISA, traditional preemption principles will not apply.  Accordingly, the question then becomes whether an employer, when it self-funds a plan exempt from ERISA, may be liable for extra-contractual remedies where it has tortuously breached the implied covenant of good faith and fair dealing.

The Ninth Circuit Court of Appeals effectively addressed whether an employer acts as an “insurer” when administering a plan that may be exempt from ERISA in Williby v. Aetna Life Ins. Co., 867 F.3d 1129 (9th Cir. 2017).  The Court found that the employer’s self-funded disability plan met both elements of the broad definition of “insurance” under California Insurance Code section 22 because: (1) it shifted one party’s risk of loss to another and (2) distributed that risk among similarly situated persons.  Id. at 1134.  Although the underlying plan in Williby was actually governed by ERISA, thus preempting the state bad faith claim, it could have qualified under the pay practices exemption to ERISA.  As the Court noted, the plan could have met the requirements for the pay practices exemption (and, therefore, California law would have applied), but the argument was rejected because it was raised for the first time on appeal.  See Id. at 1136–37.  If the plaintiff had argued for the exemption earlier in the case, it is likely that the employer, having issued disability “insurance” to its employees, could have been successfully sued for insurance bad faith.  This situation gives employees a powerful procedural tool to fight their employer’s insurance claims denials.

Conclusion

The ultimate success of an insurance litigation matter may turn on whether an insurer is vicariously liable for the actions of a third-party intermediary.  How an intermediary relates to the insurer and the insured has important legal implications.  Understanding how these relationships operate in various circumstances could have an important impact on the outcome of your next insurance litigation matter.

[1] This article was first published as Insurers’ Intermediaries: The Implications of Actions Taken by Agents, Employers and Third-Party Administrators, Robert J. McKennon and Stephanie L. Talavera, Orange County Lawyer, July 2018 (Vol. 60 No. 7), p. 42.

[2] The views expressed herein are those of the Authors. They do not necessarily represent the views of the Orange County Lawyer magazine, the Orange County Bar Association, The Orange County Bar Association Charitable Fund, or their staffs, contributors, or advertisers. All legal and other issues must be independently researched.

[3] Jeffrey W. Stempel, The “Other” Intermediaries: The Increasingly Anachronistic Immunity of Managing General Agents and Independent Claims Adjusters, 15 Conn. Ins. L. J. 599 (2009).