There is a persistent myth that insurance carriers and agents often sell their clients more insurance than they need. In fact, the opposite is more often the case. Particularly after major natural disasters, policyholders find that they did not purchase enough insurance on their properties. When looking for someone to blame, they often point fingers at their insurance agents. That’s what happened to a Mississippi insurance agency in the case of an underinsured warehouse.
The loss was underinsured by more than $10 million. A warehouse owner leased the building to a produce distribution company. The lease agreement required the tenant to obtain property insurance on the building for 100% of its replacement value. Notably, the agreement also gave the tenant the option to purchase the building at fair market value, not to exceed $4.6 million.
One of the tenant’s officers contacted their insurance agent and requested quotes for insurance on the property. He told the agent that the building had “a value of roughly $5,000,000.” The agent later requested detailed information on the building, including its square footage, year built, and proximity to the Gulf of Mexico. After receiving this information, he wrote back to the insured, noting that the building had an area of 125,000 square feet and that he was using $5 million as the building limit. He requested additional information regarding limits for the contents and other buildings. The insured replied with the requested information and indicated that the building limit was acceptable.
The location was added to the firm’s existing policy with the $5 million limit on the building. The landlord was named as a mortgagee, and the agency issued the owner a certificate of insurance. No one objected to the building insurance limit.
A fire damaged the building three months after the parties entered into the lease. The insurer’s adjuster calculated the warehouse’s replacement cost at more than $15 million. The landlord received the $5 million policy limit, then sued the tenant, insurer and insurance agent for the $10 million difference. They settled with the tenant and pursued the lawsuit against the insurer and agency. They argued that the agency and insurer were negligent in not determining the building’s actual replacement cost before placing the coverage and for not obtaining the requested 100% replacement cost coverage. They also held the insurer responsible for the agency’s actions.
The case was heard in a federal trial court which ruled in favor of the insurer and agency. The landlord appealed.
The landlord argued that, as a third-party beneficiary under the policy, it was owed a duty of care by the insurer and agent. The court rejected that argument, saying that the policy was a funding mechanism for a promise between tenant and landlord. Any duty to obtain adequate insurance was owed by the tenant. Under Mississippi law, the agent had no duty to advise the insured about its coverage needs, as the law presumes the insured is in the best position to know.
The court also noted that the landlord received the certificate of insurance showing the $5 million limit and did not object. Lastly, the court rejected the landlord’s citation of a case that involved a breach of contract claim, as the landlord was arguing that the insurer and agency were negligent and not in violation of a contract.
The insurance agency in this case accepted without question the insured’s request for a limit of $40 per square foot on a 125,000 square foot building. A number that low should have at least raised a red flag. Even if the agency did not want to increase its errors and omissions liability risk by recommending higher limits, it could have obtained quotes for higher limits and presented them as options. The insured might have persisted in buying the lower limits, but that would have been their choice.
While the agency won this case, its poor underwriting job (along with that of the insurer) contributed to a very bad situation. Agencies do not have to tell insureds what limits to buy (indeed, they probably shouldn’t), but to protect themselves and maintain good reputations, they should give their clients the chance to reconsider the limits.