Editor's Note: This blog summarizes an article on side agreements written by John Nevius, a shareholder and member of the insurance recovery practice in the New York office of Anderson Kill & Olick. Readers may obtain a complimentary copy of the Nevius article, which is being featured now on the Insurance Law Center, by clicking on the link at the end of this post.

You may have an insurance policy, but what about the side agreements? In obtaining basic workers compensation and general or auto liability coverage, policyholders of all stripes may be required to sign such things as Deductible Security Agreements, Payment Agreements for Insurance and Risk Management Services or Cross-Collaterization Agreements. Often, these “agreements” are presented as part of creative premium programs which transfer risk (and claim costs) back onto policyholders (“side agreements”). Call them what you will, but side agreements can lead to large losses and tie up credit. They also generally are subject to limited, if any, state insurance regulation.

In his article on side agreements, Nevius warns: “Make no mistake, side agreements are not part of the insurance policy and may not be approved by state insurance authorities or subject to standard legal protections for policyholder consumers. In fact, these side agreements may seek to turn such protections on their head.”

Nevius calls the numerous disputes relating to side agreements that he and his colleagues see at Anderson, Kill “Monster Sightings.” Nevius explains that these disputes generally involve so-called earned premium or retrospective premium programs. All types of other liability coverage, particularly so-called fronting policies may be impacted as well.

The article then discusses recent generalized examples involving:

• Retrospective Premium Programs
• Collateralization Agreements and Arbitration Provisions
• Deductible Security Agreements

The problem, as Nevius explains is that “[u]nder a traditional insurance policy whereby the policyholder pays a fixed premium, insurance companies are less inclined to pay legitimate claims because the more they pay in claims, the less they make in profit. In contrast, the premiums paid by a policyholder under a retrospective or earned premium type of arrangement are directly linked to the amount of claims paid by the insurance company. For this reason, an insurance company may overpay, improperly pay or otherwise mishandle claims, artificially inflate loss estimates, tack on unnecessary administration or investigation expenses, fail to recover in subrogation from third parties who may ultimately be liable for the loss or fail to take other important steps to protect its policyholders’ interests.”

The article goes on to point out how “[t]he problem is compounded by the complexity of the numbers, the presence of deductibles and a general lack of interest and experience on the part of policyholders in dealing with insurance generally. Unfortunately, the above insurance company misconduct is simply a product of basic economics – the more the insurance company pays in claims today, the more it can later charge and hold as security for future potential claims. The problem may become especially acute when a policyholder does not renew and there is virtually no direct incentive for an insurance company to minimize costs or provide service – let alone let go of money it controls.”

For these reasons, policyholders are often at odds with their insurance company regarding the ultimate valuation of the final premium or security due under the insurance policy.

To avoid drawn out litigation, Nevius recommends that policyholders:

• Stay on the look-out for insurance side-agreements purporting to provide phantom coverage or savings
• Beware of any trade practice in which additional contractual requirements are presented or demanded by an insurance company or broker after coverage is purchased and effective
• Obtain detailed explanations of premium programs and all descriptions regarding the insurance policy and coverage provided (or not included) prior to inception
• Stay well informed on how the insurance company sets reserves, manages claims and allocates losses among policy periods before obtaining these types of coverage or being compelled to sign a side agreement in conjunction with, or after, policy issuance

The article also outlines the position the majority of courts have taken in litigation that has ensued. Nevius writes:  "[a]ll state high courts that have considered the question of insurance company misconduct have ruled that a policyholder need not pay retrospective premiums when the additional premium demanded has been inflated by poor claim handling, improperly setting reserves or other insurance company misconduct. Moreover, numerous courts in many states place upon the policyholder the burden of merely producing sufficient evidence to suggest that the insurance company violated an implied obligation of acting reasonably and in good faith in handling claims. These courts place the ultimate burden upon the insurance company of persuading a jury (or other finder of fact) that it acted reasonably and/or in good faith."

The article discusses several cases in which courts have refused to enforce a purported side agreement, including Brookshire Grocery Co. v. Bomer, 959 S.W.2d 673, 678 (Tex. App.-Austin 1997, pet. denied) and Appleton Papers, Inc. v. Home Indemnity Co., 612 N.W.2d 760 (Wis. Ct. App. 2000).

The article also discusses several opinions which suggest that the regulatory provisions which are in place are not being properly complied with, such as Investors Ins. Co. of America v. Karbel Wholesale Autos Inc., 148 Misc.2d 933 (1st Dep’t 1990).

Nevius concludes: “Beware the security, collateral, retrospective or other side agreement. Professional advice from a broker or coverage lawyer is important. If you are asked to sign something after being sold coverage, review it carefully. Make sure it does not take away your rights. Be especially careful when you are pushed to sign a contract separate from the policy after the fact. If you sign an agreement, you may be bound by it even if you did not understand it or were provided with verbal reassurance that it is just a formality and will never be used against you. In real life, monsters do exist.”

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