Employment Practices Liability Insurance: The Benefits and Pitfalls

Many insurance companies offer what is known as employment practices liability insurance (EPLI). The purpose of an EPLI policy is to protect your business against the risk of heavy financial losses resulting from employment claims. Before purchasing such a policy, however, you should know that it is not a silver bullet. Employers often do not learn until a claim already has been made and the policy is being invoked what some of the drawbacks and shortcomings of EPLI coverage tend to be.

What Is and Isn't Covered

Typically, EPLI provides coverage to the employer, its executives and its employees against claims for employment discrimination, retaliation and harassment; claims for defamation, invasion of privacy and negligent supervision arising in the employment context; and claims for wrongful discharge, failure to promote and failure to hire.

However, EPLI typically will not cover claims by employees to enforce rights under the Fair Labor Standards Act (wage and hour claims), ERISA (employee benefits claims), the WARN Act (requiring certain employers to provide advance notice of plant closings and mass employee layoffs), COBRA, the National Labor Relations Act, and the Occupational Health and Safety Act regulations, as well as the state statute equivalents of each of these federal statutes. Additionally, EPLI typically does not cover the costs associated with providing a "reasonable accommodation" under the Americans with Disabilities Act (ADA), and it may not cover certain types of claims for breach of employment contract or claims by independent contractors.

These exclusions can be significant for employers. In fact, claims falling under some of these statutes or theories are increasingly common and can carry considerable exposure, including potential class claims and claims for punitive damages. This is particularly true of wage and hour claims. For example, if an employee or group of employees claim they were improperly classified as exempt, they can bring a class action lawsuit for all overtime pay for work the putative class performed in excess of 40 hours in a workweek. For an employer, this can lead to significant potential liability for back pay, liquidated damages and plaintiffs' attorneys' fees. Yet such claims likely would not be covered under EPLI.

Similarly, affirmative claims you may want to bring against employees who sue you may not be covered. So if an employee sues you for discrimination and you want to file a counterclaim for misappropriation of trade secrets, breach of duty of loyalty or breach of restrictive covenant, your EPLI may not cover the cost of pursuing those claims.

Punitive damages also generally are not covered.

Defense Costs and Selection of Counsel

Attorneys' fees and other defense costs are usually included within the limits of an EPLI policy. Since legal fees often represent the largest expense to an employer in dealing with covered claims, this is generally a beneficial feature. However, every dollar spent by the carrier defending a claim erodes the amount available to pay for a judgment or a settlement. Also, the existence of insurance coverage must be disclosed as part of discovery in most lawsuits. Once a plaintiff's attorney has this information, he or she may hold out for more money in settlement.

Employers should be aware that the defense cost feature of an EPLI policy usually also allows the carrier to control selection of counsel and influence case-handling strategy. This can have significant repercussions when it comes to settling a case. From the employer's standpoint, there is the concern that any settlement amount greater than nuisance value may encourage other employees to also sue. The insurer, however, may view an employment claim the same as other insurance claims and focus predominantly on the potential for liability and the amount of damages.

Some EPLI policies address the potential for a disagreement over settlement either by giving the insurer the right to settle without the employer's approval or, as is perhaps more often the case, by giving the employer control over settlement while adding a "hammer clause." Such a clause provides that if the policyholder refuses to accept an offer to settle a claim that the insurer is willing to accept, then the insurer will not be liable for a subsequent settlement or judgment in excess of the rejected settlement amount.

Policy Limits and Deductibles

Typically, EPLI policy limits and deductibles apply on a per claim and aggregate basis. For example, a policy may limit coverage to $250,000 for each separate claim with an aggregate cap of $1 million for all claims. In setting deductibles and limits, you should determine your comfort level. If you view EPLI as a type of catastrophic coverage for employment claims, you may want to negotiate higher deductibles that essentially leave you uncovered for smaller claims.

Policy Type, Insurer Notification and Other Factors to Consider

EPLI policies typically are written on a "claims made" basis, meaning the claim must be incurred during the coverage period and the insurer must be notified during a designated reporting period. Untimely notice to an insurer can provide a basis to reject coverage for an otherwise covered employment claim.

Employment disputes sometimes take a long time to develop into claims. Therefore, you should consider purchasing tail coverage if or when the primary EPLI policy is dropped.

There are other factors to consider in purchasing an EPLI policy. For example. insurers usually require you to select from an approved "panel" of attorneys for your defense. If you have an existing relationship with an attorney with whom you are comfortable, however, you should request that the insurer allow you to choose your own defense counsel.

EPLI is definitely not for everyone. Before you buy a policy, you should be aware of the many pros and cons, and understand what EPLI will and will not do for you