Legally speaking: TPAs — helpful product or potential nightmare?

(May 2007) For many insurance advisors who cater to business owners, third-party administrative, self-insured employee benefits (TPAs) are becoming an increasingly attractive product to add to the lineup or arsenal of suggestions.

In this evolving area of client service, TPAs, using an administrative services only (ASO) model with stop-loss provisions, are often presented as an alternative to traditional group insurance products.

There are different levels of service that employers can opt for, including: • third-party administration only;

• insurer administers the collection of premiums only;

• insurer administers premiums and claims; or

• insurer administers pensions and TPA services, and provides pension-plan consulting to the employer.

The services offered by a TPA may include processing claims, doing audits, adjusting, negotiating settlements, keeping records, self-insurance certification and advising stop-loss carriers when claims exceed the threshold amount.

The ASO arrangement allows employers to provide benefits for their employees without the perceived costs charged by licensed insurers. Often these arrangements include the need to purchase traditional insurance to cover claims above a predetermined limit, so-called stop-loss insurance.

Some marketing materials provided by some TPAs, however, use undefined industry jargon that obscures the product’s inherent financial risks, which in turn poses a significant risk for the agent.

The employer’s understanding, based on marketing materials presented at the time he or she selects a TPA, can be insufficient and cause the employer to miss the obvious and material risks that come with using an ASO. When problems occur, this communication gap will be the proverbial chicken that comes home to roost.

As with many types of “sales” materials, potential problems (those that could later become an agent’s nightmare) are not clearly stated, and the effort to simplify sophisticated concepts and complex wording results in an oversimplification of the meaning, risks and benefits. If and when problems do occur, the employer may be looking to the agent to explain and even provide compensation for claims that exceed anticipated costs.

Blame and customer dissatisfaction aside, consider for a moment the risks: Assume your client has a small group of 15 employees. What if the claims experience of that group is high in any given year? While the stop-loss provisions in place may protect the employer for that year, the contract could then be highly rated, the threshold could be significantly raised, or the threshold might be completely unavailable in future years.

As with any insurance, someone needs to pay the freight. In this case the employer is that “someone.” The end result may be an unplanned financial disaster. For example, what if an employer fails to anticipate the number of claims he or she needs to pay out? What happens if the stop-loss contract is not renewed by the insurer and the employer becomes responsible for every dollar payable to plan beneficiaries?

The challenge for agents is that employment benefits are considered to be insurance products by most, if not all, Canadian insurance regulators. The Ontario Insurance Act, for example, says insurance is the undertaking by one person to indemnify another person against loss, or liability for loss, where there is a certain risk or peril or “to pay a sum of money or other thing of value upon the happening of a certain event.” This includes life insurance.

Any party providing a contract to indemnify another party for such expenses is an insurer within the meaning of the Act. In effect, the self-insured employer is the insurer. While the employer may be an unlicensed insurer within the meaning of the Act, the employer is bound by the Act, as is the agent who receives compensation for soliciting and selling the products supplied by the unlicensed insurer.

This gives rise to several live questions about the legal relationship between the TPA and the agent in this “insurance” relationship. Another possible nightmare question that could emerge: Is the agent the reinsurer?

The rub is the Act also provides that “an agent or broker is personally liable [my emphasis] to the insured on all contracts of insurance unlawfully made by or through the agent or broker, directly or indirectly, with any insurer not licensed to undertake insurance in Ontario, in the same manner as if the agent or broker were the insurer.”

So two questions arise: 1. What is the standard of care for an agent advising on the purchase of a TPA?

2. If the agent is sued, will his or her insurer defend and/or indemnify? The devil is in the detail: As the agent is likely providing insurance service and advice when dealing with a TPA arrangement, the agent is required, as a standard of care, to perform due diligence on the TPA, on the stop-loss agreements, the alternatives, and to know the funding method risks associated with the ASO and TPA. The agent must also meaningfully communicate this information to the employer so the employer can make an informed choice.

As always, assuming that the agent fails to paper his or her files to show adequate due diligence, analysis, disclosure, recommendations and follow-up, then the agent is a target for a lawsuit if any of the negative contingencies occur. As a precaution, point out that marketing materials are not a binding contractual representation by the TPA or the stop-loss provider. That said, the agent is still responsible for all of his or her representations, including those made in marketing materials. As well, an agent must be familiar with the specific provisions in the contract.

Given the lack of regulations and standards surrounding TPA contracts, dealing with non-insurance licensed TPAs can result in real liability risk for agents if the agent does not perform due diligence and meet this standard of care.

Perhaps the best way of evaluating suitability is to obtain references from brokers and clients who have worked with the TPA for some time — I recommend that an agent inquire into the financial stability of the TPA; recently a U.S. TPA was unable to meet its obligations, and the employer, who had already paid the TPA, was required to pay a second time — but placing reliance on such references is at the agent’s own risk.

Although not all TPAs are suspect, an agent should be careful about the representations made by TPAs and inquire about their administrative capability, long-term existence, financial stability and the associated liability that comes with recommending a particular TPA to an employer.

Answers to the practical questions (Who pays if the agent is sued? Is the sale of, and advice about, TPAs covered by E&O policies?) are unclear.

As a lawyer, I can argue both sides of this question. If I were thinking like a judge, however, I would probably side with the E&O insurer in denying the claim, based on the opaque contract wording I’ve seen.

In short, advice that involves a non-licensed insurer may be outside the scope of coverage of most, if not all, plans. That said, it is often hard to predict how an insurer will interpret contract wording — a wonderful source of business for us lawyers.

In conclusion, it is important to note that ASOs and third-party administered ASOs are appropriate solutions for certain, well-informed employers with the ability to withstand the financial risks. The concern is not that the product is inherently flawed but that it is inherently risky. Also, it is essential that the agent know his or her products and not rely on unregulated representations, particularly when dealing with the wording of any “stop-loss provisions.”

As TPAs are becoming more popular, leading organizations such as CCIR/CSIRO and the Conference for Advanced Life Underwriting (CALU) are considering the duty of care and public protection. This debate is encouraging and will lead to a clearer understanding of the products and an agent’s responsibilities when selling them.

Harold Geller is an expert on legal issues affecting financial intermediaries. Harold assists and represents dealers, MGAs, branch managers, compliance officers and advisors dealing with their compliance, regulatory and negligence issues. Harold also helps financial intermediaries with internal business and their clients’ legal issues. Harold is a well-known industry commentator, a CE provider and administrator with foradvisorsonly.com. Harold can be reached at hgeller@miltongeller.com.

(05/07/07)