Appraisal management E&O coverage: Ensuring your business has a proper insurance plan
By Elaine Matternas
A business — any business — is liable for the work it performs and the services it provides. Appraisal management companies (AMCs) are liable for any errors and omissions made in the course of providing appraisal management services to their clients. Why do appraisal management companies need Errors & Omissions (E&O) insurance? Well, if you have unlimited resources to defend any potential lawsuits or are a riverboat gambler with your company’s assets, maybe you don’t. If, on the other hand, you are among the other 98 percent of the AMC population, it makes good business sense.
Quite simply, E&O insurance is a tool used to protect the assets of the company and manage risk inherent to AMC operations. On a very basic level, businesses of all types and sizes that provide specialized services rely on E&O insurance to help them respond to unforeseen situations where disagreements over performance lead to lawsuits. Even allegations that are eventually proven to be wrong must be defended. You can budget for the cost of your insurance premium, but you can’t budget for the unexpected cost of a lawsuit.
In addition, lenders and clients of an AMC demand proof of E&O coverage as part of their due diligence in their hiring, just as you look for the same proof from appraisers who are selected for your panel.
Appraiser insurance is not AMC insurance
In 2008, when many new AMCs were being formed, some owners didn’t think they needed E&O insurance because they required their panel appraisers to carry the coverage. However, the appraiser’s E&O policy protects the appraiser, not the AMC. While some AMCs have attempted to shift their liability to appraisers via indemnification clauses in their contracts, almost all errors & omissions policies — including those for AMCs — have what is commonly referred to as the “contractual liability exclusion.”
This provision excludes coverage for “the liability of others assumed by an Insured under any contract or agreement, unless such liability would have attached to the insured in the absence of such contract or agreement.” In simplest terms: You are liable for what you do; I am liable for what I do. We all know, however, that those lines can become blurred, and sometimes we disagree on the scope of services or how performance is defined. When those discrepancies move beyond minor matters, they often end up in court.
AMCs operate as intermediaries, working between the independent appraisers and the lender/client to manage the appraisal process. In that role, they are much like any other intermediary. Look at those of us in the insurance industry as an example: As insurance brokers/program managers, we operate as an intermediary between the insured or agent and the insuring company. Any time you have this type of arrangement, you increase the possibility that errors or misinformation or even misunderstood information gets passed along up and down the lines of communication. Some errors may be relatively insignificant and resolved on the spot, while others morph into major catastrophes.
Electronic communication breakdown
Remember “whisper down the lane,” the old parlor game where someone whispers a sentence that is repeated around the room, only to end up with a final version that is very different than the original sentence? You may feel that the heavy reliance on electronic communication provides more systems to manage the communication process, but the insurance industry’s experience does not support that view. Electronic communication is still managed by human beings, and as we all know, human beings are fallible. In fact, electronic communication often makes errors or omissions more apparent.
What coverage does an errors & omissions policy for an AMC provide?
First, you need to go to the insuring agreement of a policy. It usually reads something like this: “The Company will pay on behalf of the Insured all sums … which the Insured shall become legally obligated to pay as Damages and Claims Expenses resulting from Claims first made against the insured during the Policy Period or Extended Reporting Period … as a result of a Wrongful Act by the Insured or any entity for whom the insured is legally liable …” followed by whatever conditions precedent to coverage must be met for the policy to respond. All items in bold can be found in the Definitions section of the policy. In understanding the coverage outlined in the insuring agreement, you must look at each defined term. Definitions are critical in determining coverage.
You then need to look at the definition of Wrongful Act: Actual or alleged negligent act, error or omission (and sometimes personal injury) committed solely in the performance of, or failure to perform Professional Services. Then, in turn, you need to look at the definition of Professional Services. This is where you don’t want a definition of professional services that is too narrow. With insurance policies, sometimes less is more. (Wouldn’t it be nice if you could condense your insurance policy to one paragraph or even one page instead of 10 or 20?) Fewer words often provide broader coverage than when you try to define Professional Services too narrowly, and in the process, omit certain aspects of the services that you provide. Because the role of appraisal management companies is still evolving, it is prudent to negotiate a definition of professional services that is not limiting.
Next, you should a check the definition of Insured, often referred to as “who is covered.” Insurance policies only respond to liabilities of insureds under the policies. Thus, it is important that an AMC’s policy include employees as well as ownership interests.
After that, you should read the list of exclusions and determine their impact on the exposures that your company faces. Pay special attention to any policy exclusions and special endorsements that may relate specifically to the real estate industry. Some of these endorsements provide coverage extensions, while others limit coverage in some way.
Finally, you should review the conditions outlined in your policy. While these provisions normally do not preclude coverage, they can impact the timing and your rights in case of a lawsuit. Consult your agent or broker for guidance on all policy provisions.
Once you have waded through the policy language, you may wonder what types of claims are commonly made against appraisal management companies. Some of the less complicated claims involve failure to meet deadlines that delay or cancel a transaction, thereby causing financial harm to a party involved in the transaction. Others? Omitting important information that impacts the assignment. This is especially critical when changes are made in an appraisal order after it is initially assigned, and there is a considerable amount of back and forth communication that in transmitted. Other charges or allegations can involve failure to adequately perform due diligence on the appraisers assigned, or making an assignment to an appraiser who is unqualified for the task, resulting in a faulty appraisal. Failure to adequately provide supervision, monitoring or quality control are also potential claims.
The impact of insurance
Of course, the entire appraisal industry is likely aware of the massive lawsuit filed by the Federal Deposit Insurance Corp. (FDIC), as receiver for Washington Mutual, against LSI Appraisal and Corelogic in 2011, and now winding its way through the courts. One of the issues in this case that is likely to have implications for the appraisal industry is whether the independent fee appraiser is an “agent” of the AMC.
The FDIC has been aggressive in pursuing any and all avenues of possible recovery from the myriad of loans now in default that brought down so many banks. AMCs as well as appraisers are potential targets.
Another claim of major significance involving AMCs is a class action case in West Virginia against a mortgage loan originator, an AMC and a defendant class of appraisers who had done business with those entities. Allegations include predatory lending practices, the charging of excessive and unreasonable fees and inflated appraisals. When you view the aftermath of the real estate meltdown in the past four years, the continuing evolution of the role of appraisal management companies in the marketplace going forward, and the litigious nature of the society in which we live, it is likely that appraisal management companies will face a continuing array of lawsuits.
While you can’t necessarily prevent someone from filing a lawsuit against your company, there are some measures you can take to mitigate the circumstances that might lead to a claim. Chief among these steps is to establish policies and procedures for your operation that require documentation for every action. Constantly review and upgrade these procedures, and test your own performance with internal audits. Do the same with your procedures for qualifying appraisers for your panel. Make sure that company policies are communicated to all employees from top to bottom. Hire, train and manage a staff of individuals who are qualified to do the work you are asking them to perform. Make sure you are current with all of the new AMC laws and requirements from the various states.
Remember that no E&O policy covers everything. Sometimes it seems that we have become so risk-averse in this society that we want guarantees we are protected 100 percent of the time for 100 percent of the things that can go awry. Since there is no 100 percent solution, you need to be a smart buyer: Know your tolerance for risk, ask questions and demand intelligent answers, and carefully select the policy and coverages that fit your needs.
Elaine Matternas oversees professional liability programs at Intercorp Inc., an insurance program management firm headquartered in Ephrata, Pa., which has been serving the appraisal industry for almost 20 years. This article is intended as a general overview of the subject, and not to provide specific legal or insurance advice.