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WORKERS' COMPENSATION INSURANCE: EMPLOYER/INSURER LIABILITY
By Mike Abourezk
Litigation of a bad faith action against an employer processing a worker's compensation claim may involve issues that do not arise in other types of insurance coverage. Some of these issues are:
1. Whether the exclusive remedy provision in the South Dakota worker's compensation law precludes an employee from suing an employer for insurance bad faith;
2. Whether an employer that pays its own worker's compensation claims, but has not sought formal certification as a self-insurer, can be sued for insurance bad faith.
A. Exclusive Remedy
An employer/insurer may argue that it cannot be sued for bad faith because of the exclusivity provision of the worker's compensation law. There is no merit to this argument. Bad faith is an intentional tort. South Dakota Codified Law § 62-3-2, the exclusive remedy provision of the law, clearly excludes intentional torts from the scope of the statute. South Dakota Codified Law § 62-3-2 provides in pertinent part:
The rights and remedies herein granted to an employee subject to this title, on account of personal injury or death arising out of and in the course of employment, shall exclude all other rights and remedies of such employee,..., except rights and remedies arising from intentional tort. (emphasis added).
The seminal bad faith case that involved the exclusive remedy provision of worker's compensation law is Champion v. United States Fidelity & Guaranty Co., 399 N.W.2d 320 (S.D. 1987). In Champion, the Supreme Court found this legal reasoning persuasive:
The Compensation Act should not be a "shield" which will insulate those who would engage in intentional wrongdoing in the settlement and investigation of worker's claims. No one should be allowed intentionally and tortiously to cut off a claimant unilaterally for whatever purpose they choose and then hide behind worker's compensation exclusivity in assurance that the only retribution will come in the form of a compensation penalty paid for by society.
Id. at 323, quoting Hayes v. Aetna Fire Underwriters, 609 P.2d 257, 262 (Mont. 1980).
In Champion, the Court held "that the exclusivity provision of the Worker's Compensation Act does not bar an action by the employee against the insurance carrier for the commission of an intentional tort. The independent tort is not compensable under our Worker's Compensation Act and to extend immunity to compensation carriers for a separate injury to workers goes far beyond the intent of the act." Id., citing Southern Farm Bureau Cas. Ins. v. Holland, 469 So.2d 55 (Miss. 1984).
B. Bad Faith Actions Against Self-Insured Employers
In worker's compensation cases, it is important to determine whether an employer is self-insured or has acted as a self-insured for purposes of liability for bad faith. In South Dakota, it is undisputed that self-insurers can be sued for the intentional tort of bad faith. See, e.g., Gilchrist v. Trail King Industries, Inc., 655 N.W.2d 98 (S.D. 2002); also Gilchrist v. Trail King Industries, Inc., 612 N.W.2d 10 (S.D. 2000) (Gilchrist I); Gilchrist v. Trail King Industries, Inc., 612 N.W.2d 1 (S.D. 2000) (Gilchrist II) (Employee sued self insured employer for bad faith in handling worker's compensation claim); Zuke v. Presentation Sisters, Inc., 589 N.W.2d 925 (S.D. 1999) ( Employee brought bad faith action against employer and employer's insurer. However, employee failed to exhaust administrative remedies); Arp v. AON/Combined Ins. Co., 300 F.3d 913 (8th Cir. 2002) (Injured employee sued his employer, the third-party administrator of his employer's worker's compensation program and his employer's worker's compensation insurance carrier for bad faith).
Other states also permit employees to sue their employer/insurers. For instance, the Colorado Supreme Court in the landmark case of Travelers's Ins. Co. v. Savio, 706 P.2d 1258 (Colo. 1985) applied bad faith law to "providers of insurance." In Mississippi, employees may sue their employers or insurers for bad faith. See Ray v. Travelers' Ins. Co., 1998 WL 433949 (N.D. Miss. 1998) ( Mississippi Supreme Court held that a bad faith cause of action may be brought against an employer or insurance carrier and is not barred by exclusive remedy provision, citing Luckett v. Mississippi Wood , Inc., 481 So.2d 288 (Miss.1985)).
In McIlravy v. North River Ins. Co., 653 N.W.2d 323 (Iowa 2002), the Iowa Supreme Court said:
The second method by which a self-insured employer or employer's worker's compensation carrier may be penalized for a delay in payment of benefits is by a private cause of action for first-party bad faith. This cause of action arises from "the knowing failure to exercise an honest and informed judgment" on the part of a defendant from whom the employee seeks compensation due to work-related injuries.
Id. at 328-29, citing Kiner v. Reliance Ins. Co., 463 N.W.2d 9, 12 (Iowa 1990)(citation omitted)(emphasis added).
Similarly, in Buote v. Verizon New England, 190 F.Supp.2d 693 (D. Vt. 2002), an employee brought an action against his self-insured employer for bad faith handling of his worker's compensation claim. The Vermont Supreme Court held that material issues of fact did exist and that the employee could pursue the claim.
C. High Deductible Insurance Policies and Fronting Agreements
1. Generally
An employer's worker's compensation insurance policy may contain a "fronting agreement." Fronting agreements are a device used by self insurers to satisfy various financial responsibility laws, including the statutory requirements that employers purchase worker's compensation insurance. These agreements, on the surface, appear to provide insurance coverage. However, if one reads the side agreements and endorsements, most if not all of the coverage is excluded in one manner or another. Fronting agreements are a device used by self-insurers to satisfy various financial responsibility laws, including the statutory requirements that employers purchase worker's compensation insurance.
For instance, S.D.C.L. § 62-5-1 et. seq. requires that an employer in South Dakota must choose between three alternative methods of providing worker's compensation protection: (1.) an employer may obtain worker's compensation insurance from a licensed insurer ; or (2.) an employer may join an association of employers organized for the exchange of reciprocal insurance contracts for the purpose of indemnifying each other from loss under the worker's compensation law ; or (3.) an employer that wishes to be self-insured must enter into contractual agreements with his workers to provide a scheme of compensation benefits by the employer, and must also receive approval of the department.
This third option involves very specific requirements. In order to be self- insured, an employer is required to enter into contracts with all employees, and furnish satisfactory proof to the department of labor of the employer's financial ability to pay the compensation required by the worker's compensation act. S.D.C.L. § 62-5-5. A self- insured employer also is required to furnish a bond, written by a surety company, and authorized by the division of insurance to write surety bonds, or cash, or a certificate of deposit, or a irrevocable letter of credit, in a total amount equal to the greater of: (.1) $250,000; or (2.) twice the amount of compensation claims paid by the employer during the preceding calendar year; or (3.) the amount designated by the employer as a reserve for worker's compensation claims. S.D.C.L. § 62-5-10.
2. Nature of fronting agreements
Fronting agreements have been described in numerous court decisions. For instance, an Ohio court of appeals characterized a "fronting agreement" as a method where a self-insured entity simply "rents" an insurance company's licensing capability:
In this case, the ACE policy includes a total deductible amount which is equal to the policy limits. Under the terms of the policy language, any administrative expenses including costs of defense in handling claims are also included as costs which accrue against the policy limits. This type of policy constitutes a "fronting agreement" which is a method of administering insurance claims by "renting an insurance company's licensing and filing capabilities in a particular state or states." (emphasis added) .
Kohntopp v. Hamilton Mutual Ins. Co., 2003 WL 21255940, 13-14 (Ohio App. 6 Dist. 2003) (not reported in N.E.2d).
In Chicago Ins. Co. v. Travelers Ins. Co., 967 S.W.2d 35 (Ky. App. 1997), Travelers issued a general commercial liability policy to Walgreen Company. Walgreen admitted that the policy was a front, and was issued primarily for the purpose of providing a certificate of insurance to various municipalities and vendors:
The Traveler's policy is essentially a "fronting policy" pursuant to which Walgreen is self-insured for the $1,000,000.00 of coverage provided by the policy . . . In its brief, Walgreen admits that this is a "fronting policy" which essentially require[s] it to indemnify Travelers for any payment because the policy has a $1,000,000.00 deductible and a $1,000,000.00 coverage limit. (emphasis added).
Id.
Continuing, the court concluded:
Therefore, the policy effectively provides the terms of Walgreen's plan to be self-insured for $1,000,000.00. Walgreen explains that "[t]he policy was issued primarily for the purpose of providing certificates of insurance to various municipalities and vendors...."
Id.
In another case, Playtex FP, Inc. v. Columbia Casualty Co., 609 A.2d 1087 (Del.Super.1991), the Delaware court described the testimony pertaining to a fronting arrangement:
Northwestern was in the business of selling fronting programs. It helped large insureds with self-insurance type mechanisms, such as captive fronting arrangements, matching deductible, or large deductible programs, and some self insurance programs. . .. Stein has testified that the fronting concept was defined by Esmark in the marketing of its insurance program as an articulation of Esmark's self-insured retention, and stated that "Northwestern described their program as a deductible equals limits program. . .."
Id. at 1091.
Fronting policies can take a number of different forms. The common denominator though is that the insured still pays its own claims. The Delaware Court elaborated in the Playtex case as follows:
There is no common way of effectuating fronting policies. Deductible equals limits policies are one method. Esmark contends that the Northwestern fronting policy was accomplished with the use of two documents: a hold harmless agreement, and a deductible endorsement. The hold harmless agreement said there would be no losses reported under the policy, and if there were, Esmark would have to reimburse Northwestern for all of its expenses. . .. Under the deductible endorsement there was no risk transferred to the insurance carrier, as the deductible was to become part of the fronting policy and equal the limits. . ..
* * *
Dr. Joseph A. Fields (Fields), a second Columbia expert, testified that fronting arrangements are often done under a captive reinsurance agreement when the front is needed to secure a certificate of insurance for a regulatory or contractual purpose. Hold harmless agreements are used to make policies into fronts, typically when the insured has credit problems. (emphasis added).
Id. at 1091.
3. Large Deductibles or Fronting Agreements Constitute Self-insurance
Many of the courts examining this issue have held that large deductibles or fronting arrangements actually constitute self insurance. For instance, in Air Liquide America Corp. v. Continental Casualty Co. v. CIGNA Property & Casualty Co., the Tenth Circuit Court of Appeals reached a similar decision. 217 F.3d 1272 (10th Cir. 2000). The court held that a trucking company's "fronting" liability policy, with a deductible equal to the policy limits, was actually a form of self-insurance and that the insurer acted merely as a surety for the insured's ability to satisfy a judgment.
In Straubhaar v. CIGNA Property & Casualty Co., an Ohio appeals court held that an employer who purchases a liability policy with a deductible equal to its liability limits was "self-insured" in the practical sense." 2002-Ohio-4791, 2002 WL 31040683 3 (Ohio App. 8 Dist.2002). See also Cincinnati Ins. Co. v. Torok, 787 N.E.2d 1257 19 (Ohio App. 7 Dist.2003) (holding that an employer was self-insured "in the practical sense" where there was a "reimbursement indemnification and security agreement" executed between the employer and the insurance provider).
An Illinois Court of Appeals agreed with defendant Continental Casualty Company, when it argued that the plaintiff had only purchased "fronting" insurance, requiring reimbursement of all sums paid for defense or indemnification, and that the plaintiff was in effect self-insured. United States Gypsum Co. v. Admiral Ins. Co., 643 N.E.2d 1226, 1260 (Ill. App.1 Dist.1995).
As discussed, in Chicago Ins. Co. v. Travelers Ins. Co., the Kentucky Court of Appeals equated a fronting policy with a scheme of self-insurance. The court said that:
In fact, the Traveler's policy was nothing more than a "fronting policy" for Walgreen's self-insurance scheme. (emphasis added).
967 S.W.2d 35 at n.1.
D. Employer's Lack of Certificate of Self-Insurance
An employer may argue that it has not received a certificate of self insurance, as required by S.D.C.L. § 62-5-4. Indeed, avoidance of such statutory requirements is one of the primary purposes of a fronting agreement. However, the employer may be the real party in interest for the payment of claims, including cost of defense, and the involvement of the insurance company is simply a front.
The Eighth Circuit Court of Appeals, in Arp v. AON / Combined Ins. Co., 300 F.3d 913 (8th Cir. 2002), considered a similar situation. In that case, the Eighth Circuit allowed a bad faith claim to proceed against both the self-insured employer and the third party claim administrator. The self-insured employer in AON did not obtain a certificate of self-insurance from the Department of Labor. The Eighth Circuit nevertheless considered the employer to be self-insured and stated as follows:
[Employer] is self-insured for workers' compensation up to $500,000.00. Claims exceeding $500,000.00 are paid by Continental. At the time of James's accident, the administration of [employer's] workers' compensation program was managed by GAB, a third party administrator.
Id. at 915 n. 1(alteration added).
Certainly, an employer's failure to obtain formal self-insured status is not dispositive of a bad faith claim. The decision of the Wisconsin Supreme Court in Hillegass v. Landwehr, 499 N.W.2d 652 (Wis. 1993) is instructive. In that case, the Wisconsin Supreme Court had to decide whether a self-insured employer would qualify as "other insurance" under the definition commonly found in insurance policies. That definition subordinates its coverage to pay only after any "other insurance" has paid its limits. The Wisconsin court specifically noted that the employer had not applied for or received certification as a self-insurer under Wisconsin statutes. Nonetheless, the court held that the defendant had chosen to conduct itself as a self-insurer.
The court first discussed the definitions of "insurance:"
Black's Law Dictionary . . . defines "insurance" as "[a] contract whereby, for stipulated consideration, one party undertakes to compensate the other for loss . . . ." Similarly, Webster's New Collegiate Dictionary (1980 ed.), defines "insurance" as "a contract whereby one party undertakes to indemnify or guarantee another against loss . . . ." Whether the contract is one of indemnity or liability, the critical element in both definitions is a contractual shifting of risk in exchange for premiums. . . .
Id. at 654-55.
Then the court said :
Whereas contractual insurance policies involve a third-party insurer underwriting the insured's risk in exchange for premium payments, self-insurers retain their own risk in exchange for not paying premiums. . .. In the words of the circuit court: "self-insurance is just a form of insurance . . ., the modifying term 'self' just indicates where it emanates. . .."
Id. at 654-55 (emphasis added)..
In Hillegass, the Wisconsin court noted that employers are free to choose this type of fronting device by agreeing to reimburse their insurers for the first $1,000,000.00 rather than pay premiums on that risk. However, the Wisconsin court also held that employers who wish to retain their own risks and liabilities do so subject to the obligations and duties that arise from choosing to self-insure.
The court stated that:
Farmers asserts, and we agree, that it would be fundamentally unfair and contrary to legislative intent to permit companies such as Burlington Air Express to self-insure and thereby escape both the expense of premium payments and the possibility of being held liable as a primary insurer. See, e.g., White v. Howard, 240 N.J. Super. 427, 573 A.2d 513 (N.J. Super. A.D.1990). As noted supra, the fact that the legislature permits companies to formulate the most efficient insurance coverage should not be misconstrued as a device to avoid liability by the self retention of risk.
Id. at 655-656 (emphasis in original and added).
Again, the Wisconsin court specifically stated that the employer in this case, Burlington Air Express, was not a certified self-insurer as specified by Wisconsin statute. Nevertheless, the court concluded that:
. . . permitting individuals to self-retain risk was not intended by the legislature to be a device by which self-insurers could escape the liabilities that would attach to third-party insurers.
Id. at 656.
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