Sometimes, an insurance agency cannot place a risk with any of its markets and needs outside reach out to a wholesaler. While there are over a thousand of wholesale brokerages available to assist in these situations, most of are trustworthy. Not all of them are, however, and the more brokers that get involved with a transaction, the greater the chance that one of them will be a problem. A California agency and its affiliated risk purchasing group learned this in a painful way.
The risk purchasing group enabled owners and managers of commercial properties to buy insurance. It represented more than 600 properties, including office buildings, shopping centers and residential complexes, with total insured values of almost $3.5 billion. The insurance agency, whose sole owner was also the purchasing group’s sole owner, administered the group.
When the agency started marketing the group’s renewal coverage, it contacted a brokerage in Texas that specialized in habitational and commercial real estate risks. Due to the large values involved, the Texas brokerage enlisted an Ohio brokerage, which brought in yet another brokerage, JRSO, with which it had previously done business. JRSO was to obtain the insurance. JRSO hired another Ohio brokerage to be the program administrator for this group of properties.
During the renewal placement process, the Texas brokerage concluded that it would be less expensive if one group of properties, which had a poor loss history, was written separately. Acting on the first Ohio brokerage’s advice, the agency and the Texas brokerage placed coverage for this group directly with JRSO.
The program administrator tried to win a larger role in placing the business, but JRSO refused to let it get involved, citing concerns about thin profit margins. When the transaction concluded, none of the proposals or price quotes came from the program administrator, nor did the administrator receive any commission.
During the process, the administrator noticed warning signs about JRSO’s operations but did not notify the purchasing group and its agency. It turned out that JRSO issued phony insurance policies, not issued by a legitimate insurer, for the purchasing group and the group with the poor loss history. The original agency had to obtain replacement coverage for $2 million more in premium. After the scam came to light, the principal of the brokerage was convicted of wire fraud, sentenced to 10 years in prison, and ordered to pay more than $9 million to his victims, including the purchasing group.
The purchasing group and agency sued all of the other brokerages involved for negligence and breach of fiduciary duty. All of the suits settled except for that against the program administrator. The trial court ruled in the administrator’s favor because it was not involved in the insurance placement.
The appeals court agreed. It said that the program administrator could not have been negligent in its dealings with the purchasing group because it was not involved in the insurance placement, much as it wanted to be. It owed no fiduciary duty to the group because it did not participate in the placement or receive any compensation for it. It did not owe a duty of care to the agency because the agency was not an insured under the issued policies. There was also no breach of fiduciary duty to the agency because the administrator did not misappropriate the agency’s funds; it only handled the premium forwarded by the agency.
While the court cleared the administrator of any wrongdoing, this case illustrates the importance of performing due diligence on any potential business partners. The program administrator became aware of legal action taken against the dishonest brokerage; the other brokers in the chain could also have uncovered this information. The brokerage’s principal operated out of his home because a court had ordered confiscation of the business’s property. There were also irregularities with the brokerage’s reinsurance agreements. Any one of these factors should have been warning signs about the business’s trustworthiness.
In a complex insurance transaction such as this, with multiple agencies and brokerages involved, any single participant can cause problems for the rest. It is imperative that each participant be able to trust the others, and that requires performing due diligence. As the old Russian proverb goes, “Trust but verify.”