While insurance buyers at real estate companies have primarily focused their attention on the renewal of their property insurance programs—and the challenge associated with obtaining terrorism coverage—they risk being unprepared for the impact of insurance market conditions on other lines of coverage.

In fact, one area that should be of particular concern is employment practices liability (EPL) insurance. While the losses associated with the September 11 terrorist attacks have had an industry wide impact on insurers, the lingering economic downturn has also further exacerbated trends that were already underlying premium increases for EPL coverage.

The result is that even those REITs without a claims history have faced premium increases of 40 percent to 60 percent upon renewal of their EPL insurance in the first quarter of 2002. Moreover, insurance carriers have demanded that REITs retain additional risk, by significantly increasing their deductibles.

Why the hard market for EPL insurance? The answer is three-fold.

Business Environment

REITs are not immune from the litigious U.S. business environment. It has become increasingly common for employees to file claims alleging wrongful termination, sexual harassment, and discrimination based on age, race, gender, religion or disability. Over the last 10 years, employment practices-related settlements negotiated by the U.S. Equal Employment Opportunity Commission have more than doubled, approaching $250 million in 2001 alone.

Furthermore, a recent U.S. Supreme Court ruling, easing the burden of proof for workers alleging discrimination, promises to propagate the trend of increasing EPL claim frequency and severity. Some recent examples of such employment-practices claims from the REIT industry:

• A male employee claimed that he was discriminated against on account of his sex, alleging that, on several occasions, he was passed over for promotion in favor of females with less experience and qualifications.
• An employee alleged that she was terminated on account of her age, 55.
• An employee alleged that he was unfairly denied an opportunity to apply for a position, and harassed, because of his national origin.

Insurance Cycle

The second factor driving changes in the market for EPL insurance is the cyclical nature of the insurance business. Until mid-2000, REITs were beneficiaries of an unusually soft market for EPL coverage. In the latter half of the 1990s, many companies experienced year-on-year rate decreases, while benefiting from low deductibles and extremely broad coverage terms and conditions.

Even as insurers engaged in vicious competition for market share, underwriting losses built up at a staggering pace. Rising EPL settlements were compounded by the exploding cost of defending the mounting claims. Legal defense costs alone can exceed $250,000 in an EPL-based lawsuit. These factors have contributed to an unsustainable underwriting environment.

As insurers exit the market for EPL insurance, coverage has become increasingly scarce. This is particularly the case for those REITs with a history of EPL claims. In addition, while insurance carriers once readily offered coverage for third-party EPL claims, brought, for example, by customers or vendors, they are now extremely reluctant to do so.

U.S. EEOC Discrimination Filings*, 1992–2001

*Total number of individual charge filings under all statutes enforced by EEOC (Title VII, ADA, ADEA and EPA). Source: U.S. Equal Employment Opportunity Commission

Economic Environment

Leery insurers expect that layoffs—driven by bankruptcies and organizational restructuring—will stimulate a surge in EPL claims. Certainly, there will be a spike in claims alleging wrongful termination, but insurance carriers also expect an increase in claims of harassment and discrimination.

In a flourishing economy, a disgruntled employee might change jobs rather than face the daunting prospect of conflict and litigation. By contrast, when jobs are less plentiful, instances of harassment and discrimination are less likely to go unchallenged.

Be Prepared

So, how should REITs respond to the challenge of a hard market for EPL insurance? Buyers should anticipate—and be prepared for—significantly higher premiums. This is particularly the case for those companies that are coming to the end of a multi-year policy.

Indeed, in an environment where every penny counts, some firms may have to make difficult decisions. Real estate companies with superior loss histories and effective human resources risk management programs may consider sig nificantly increasing their deductibles, above those demanded by insurers. By purchasing EPL policies with deductibles of $50,000, $100,000 or higher, REITs may somewhat mitigate the impact of rising insurance costs, while still maintaining protection from catastrophic claims.

Another key for insurance buyers is to critically review renewal proposals for significant changes in terms and conditions. Some insurers no longer provide coverages—such as for third-party claims—that were afforded in years past. Policy areas that should be examined carefully include the various types of claimants who would be subject to coverage and definitions of who qualifies as an insured.

Other coverage issues that require particular consideration include the company's exposure to prior acts, selection of defense counsel and settlement control provisions. REITs should also consider whether to purchase a stand-alone EPL policy or to include EPL coverage as an addition to another policy, such as a directors and officers liability policy.

The hardening EPL market underscores the need for REITs to conduct comprehensive evaluations of their risk management and human resources practices and procedures.

Management controls and training programs are key to mitigating and preventing EPL claims. Furthermore, many liability policies, including EPL insurance, require that the insured provide timely notice of claims. Effective structures need to be in place to ensure that employee grievances are immediately brought to the attention of the company's risk management department.

Insurers are meticulously reviewing these controls, not only to see that appropriate risk management policies are in place, but also to ensure that they are being followed in practice. Common underwriting inquiries include questions about workforce reductions (past and anticipated) and the involvement of appropriate legal counsel in conducting such lay-offs.

In conclusion, cyclical insurance industry and macroeconomic factors, coupled with long-term legal and societal trends, have contributed to a challenging environment for purchasers of EPL insurance. To mitigate significant premium increases, REITs must take a proactive role in the renewal process.