Below is an excerpt from Marsh's FINPRO Insights Newsletter, a ...

Below is an excerpt from Marsh’s FINPRO Insights Newsletter, a quarterly newsletter with timely
information about financial and professional risk issues. If you wish to receive a complete copy of
the newsletter or to be added to the distribution list for future issues, contact Leah Ohodnicki at
Leah.E.Ohodnicki@marsh.com or 412-552-5253.
The Curious Case of Punitive Damages in Employment Practices Liability Cases
By Adeola I. Adele, Marsh FINPRO Employment Practices Liability Product Leader
Imagine this scenario: an employee sues his employer/company and supervisor in California
federal court for sexual harassment. The employee wins and is awarded $300,000 in
compensatory damages and $2,000,000 in punitive damages (generally awarded to deter the
defendant from future egregious conduct) pursuant to Title VII of the Civil Rights Act and
California’s Fair Employment and Housing Act. The punitive damages are awarded against the
company, because evidence at trial showed that for a period of two years the employee was
sexually harassed by his immediate supervisor; and the company’s human resources department
was aware of the harassment yet failed to take appropriate remedial measures. Thereafter, the
company looks to its employment practices liability insurance (EPLI) and requests payment of
both the compensatory and punitive damages under its EPLI policy. The insurer agrees to pay
the compensatory damages, but denies coverage for the punitive damages, citing California’s
public policy against insuring for such damages.
Unfortunately, the foregoing set of events is all too common. Presently, 25 states permit
insurance coverage for punitive damages, regardless of whether awarded directly against the
company or vicariously, because of the unratified conduct of a company’s employees, directors or
officers. Eight (8) states, including New York, prohibit insurance coverage for punitive damages,
and seven (7) states, including California, only allow such coverage in the vicarious liability
context. The remaining states have either not decided the issue of insurability of punitive
damages in the context of employment practices liability (EPL) or have yielded inconsistent
results.
To quell the concern over punitive damages awards, buyers of EPLI coverage can find some
solace in the knowledge that the majority of EPL claims settle before trial or final judgment, so the
issue of insurability of such damages is rarely before a court. Still, for those cases that do
proceed to trial and where punitive damages remain a concern, many EPLI buyers address the
concern by ensuring that their EPLI policies provide that insurability of punitive damages is
subject to the law of the “most favorable jurisdiction.” This provision allows the insurer to look to
the law of the jurisdiction which most favors the insurability of punitive damages. Thus, in
deciding whether to pay a punitive damages award, insurers examine whether the insured has a
substantial relationship in the geographic location where: (1) the punitive damages were awarded
or imposed; (2) the alleged wrongful employment act occurred; (3) the insured company or
insurer is incorporated, resides or has its principal place of business; or (4) the policy was issued
or became effective.
Although parties are free to include a choice-of-law provision in the insurance policy, an
unresolved question is whether a court in a jurisdiction where punitive damages are uninsurable
would enforce a most favorable jurisdiction provision. This unresolved question has caused some
EPLI buyers to purchase punitive damages wrap-around policies (“puni-wrap”). Puni-wraps are
typically available in the off-shore insurance markets, such as Bermuda, and are intended to fill
the coverage gap in situations where the domestic EPLI insurer is prohibited from providing
coverage for a punitive damages award due to jurisdictional constraints. Bermuda insurance
markets are able to offer this coverage, because they are not subject to insurance regulations
promulgated in the United States (“U.S.”). A puni-wrap can generally be purchased at a cost of
10% to 15% of the premium of the domestic EPLI policy.

Finally, purchasing a stand-alone EPLI policy from Bermuda perhaps offers the most assurance
that punitive damages would be eligible for coverage (subject to all other terms and conditions of
the particular policy), because such damages are automatically included in the policy. Similar to
the puni-wrap, stand-alone EPLI policies purchased in Bermuda are not subject to U.S. insurance
regulations.
Punitive damages remain the single largest exposure facing companies in EPL cases, with such
damages being awarded in nearly 20% of all cases that proceed to trial. These damages are also
often a factor in the settlement of cases, thus driving up the settlement value. Therefore, as the
current economic conditions continue to contribute to an increase in frequency and severity of
EPL claims, obtaining insurance coverage for punitive damages, to the extent permitted by law, is
of paramount importance.
Marsh will host a seminar on Employment Practices during Difficult Economic Times on
November 4. Adeola Adele will be a panelist at this seminar. If you are interested in
learning more, please contact Leah Ohodnicki at Leah.E.Ohodnicki@marsh.com or 412-
552-5253.