E&O Claim Scenario: To Borrow or Not To Borrow

Facts

Mr. and Mrs. Smith are high net worth individuals. Much of their wealth, however, is in real estate. A few years ago, they met with an Insurance Agent who identified a life insurance need. Based on their situation, the Agent concluded that the Smiths could use $5 million in life insurance coverage.

The Agent recommended a whole life policy that earns dividends and builds cash values. Based on their age and health, the annual premium for such a policy was $175,000. The Smiths did not have that much cash available to pay out of pocket premiums since their portfolio was comprised of primarily illiquid assets.

Policy is Purchased

The Agent advised them that they could still pay for the policy through premium financing. He suggested that they could borrow the money for the first few of years of policy premiums based on their good credit. Then, future premiums could be paid by the accumulated cash values in the policy.

He showed them an illustration that made the purchase of the policy seem like a great plan, and the Smiths agreed to the premium financed purchase. They planned to borrow the first four years of premiums and have the policy fund itself thereafter.

Now, four years into the policy, the earned dividends are materially less than what were originally projected. As a result, the Smiths were faced with the decision to keep borrowing $175,000 per year to pay premiums or to give up the policy. They had already borrowed $525,000 plus interest and could not afford the prospect of continuing to borrow $175,000 for the foreseeable future.

Complaint Letter Sent to Agent & Insurance Company

The Smiths were very unhappy with the Agent as they believed the illustrated premium financing plan to be a sure thing. They sent a complaint letter to the Agent and the Insurance Company claiming he, the Agent, portrayed this funding mechanism as a guarantee. They have borrowed over $525,000 in premiums and stand to lose both the policy and the premiums.

The Agent states that the illustrations were caveated as not guaranteed and he never guaranteed that they would not have to pay after year four. However, there are letters and e-mails from the Agent to the Smiths that portray this arrangement as very reliable.

Lessons Learned:  

• Premium financing insurance claims tend to be large because the policies typically have high limits, the premiums are large and often collateral is lost or is being vigorously pursued by the premium financing company. Therefore, documentation with respect to the mechanics of the financing and the risks associated with this type of transaction should be fully and comprehensively provided.
• Agents should work with the client’s attorney to ensure that the financing structure is proper. Also, including the attorney at the outset provides protection for the Agent in the event the insurance plan does not go as anticipated.
• Also, in some States, once an agent or broker promotes the idea of premium financing, he or she may propel him or herself into a fiduciary or special relationship, which can give rise to, among other things, heightened duties of care/disclosure in the transaction.

DISCLAIMER:

This article/blogpost is provided for informational purposes only, does not necessarily represent Aspen’s views, and reflects the opinion of the authors in light of market, regulatory and other conditions which may change over time. Aspen does not undertake a duty to update the article/blogpost.