What is a “Change” in Risk?

Author: Chris Boggs

Recently the VU has received a number of questions around the topic of mid-term cancellations. Evidently carriers are beginning to threaten this more and more; and more and more the carriers seem to think they can make this call simply because there is something they don't like about the insured.

Unfortunately for the carriers, it's not this easy or simple. Unfortunately for the agents, the statutory requirements allowing mid-term cancellation are just fuzzy enough to make fighting these claims and actions difficult.

Let's try to clarify the application of these mid-term cancellation statutes.

In June 2017, the VU published a state-by-state spreadsheet detailing state laws regarding mid-term policy cancellations. Many states allow mid-term cancellation only in certain circumstances. Regulations use different phrasing such as:

A substantial change in risk assumed….
A change…that results in material added risk, a materially increased risk, or a materially changed risk….
A substantial change in the exposure or risk….
A material increase in the hazard insured….
…a change in the risk which substantially increases any hazard insured against….
Change in the risk which materially increases the risk of loss after insurance coverage has been issued or renewed including, but not limited to, an increase in exposure to regulation, legislation or court decision.
The risk originally accepted has measurably increased.
There is a substantial change in the scale of risk….
Changes…which have materially increased the hazards….
The risk originally accepted has substantially increased.

Although this is not a listing of every state's “change in risk" wording, this list adequately represents the variations found.

(Note: One state (and only one) allows mid-term cancellation when/if there is an increase in exposure resulting from new regulation, legislation or court decision. It seems highly inappropriate to allow a carrier to drop a risk just because of a court decision. Idaho should reconsider such a position.)

When considering these statutes, when is mid-term cancellation allowed? Several key words must be understood to properly answer this question. Note that the following explanations include any variations of the term:

Risk: Within insurance this term is used in one of two ways. First, underwriters and agents often use this term interchangeably with the “insured." The underwriter says, “Tell me about the risk." What they are saying is, tell me about the insured and what they do. This is not how the term should be understood or applied in relation to these mid-term cancellation statutes. “Risk" in these statutes is given its traditional meaning – uncertainty regarding future event. Insurance is designed to provide a source of financing when something bad occurs; but to be considered “insurable," the possibility of that bad thing occurring must be very low. When the “risk" of uncertainty is initially underwritten, the insurance carrier is basing its decision on “statistical uncertainty" meaning they don't know what will happen, but they can estimate the chances based on the characteristics of the insured. When those characteristics change, the uncertainty changes which means the “risk" changes. These changes could lower the risk or increase the risk; I doubt the carrier is bothered by a lower risk, so the easy assumption is the statutes relate to an increase in uncertainty (increase in risk).
Substantial: Although somewhat self-explanatory, “substantial" means large, major, significant, great…. When “substantial" is used, it portrays something that significantly alters the nature of the risk.
Material: This term carries with it many of the same attributes as “substantial." A “material" change is one that wholly alters the outlook. In underwriting, a fact is considered material if: 1) the underwriter would have made a different underwriting decision; 2) the underwriter would have charged a different premium; or 3) the underwriter would have applied different terms and conditions. A material change in risk (uncertainty) follows the same logic.
Increased: The likelihood of an adverse outcome is greater than originally planned because the operations or characteristics of the insured change significantly.
Hazard: A “hazard" is something that increases the likelihood of a loss occurring. There is always the “risk" that a fire could occur at a building; but if you store 300 gallons of flammable and combustible liquids in that building, you increase the likelihood of fire damage. The flammable and combustible liquids are the “hazard" that increases the “risk."
Exposure: Depending on which side of the fence you are on, “exposure" has a couple of meanings. From the audit side, this means the payroll, sales or whatever is used to price the insurance. When the insured's payroll increases, the exposure basis increases. Although this is not the intended meaning in these statutes, this application of the term does directly relate to how the term “exposure" applies in these statutes. Essentially, “exposure" relates to the factors that could cause a loss. Taken alone, this term is indeterminant in regard to mid-term cancellations.
Measurable: Although we know what “measurable" means, this term is rather non-specific on its own. How measurable does the change have to be to allow for mid-term cancellation?
Change: It isn't what it used to be; there has been a “change." What the insured did before is not what is done now. The underwriting factors aren't what they were or what the carrier was told. Something is different. But again, this term cannot be used without a qualifier. Insureds are forever “changing" to some extent, the right to cancel mid-term cannot be allowed simply because of a “change."

With these terms defined, review the statutes once again. Note that each statute requires a substantial or material change in the operational or condition of the risk initially insured. Basically, a carrier can issue mid-term cancellation only when the operations have changed significantly, or the conditions are materially changed.

For example, a material change in operations might include a deli that begins to serve mixed drinks in the evening to increase profits. A significant change in conditions might include a restaurant that originally occupied a non-combustible building, but due to renovations and additions, the building is now classed as a frame building. A combination change might be a steel fabricator that begins working with magnesium (a combustible metal when grinding and shaving).

Ultimately, mid-term cancellations aren't allowed just because the underwriter doesn't like something the insured is doing or where they are operating. There must be a major change in operations or conditions before a mid-term cancellation is allowable. Basically, the insured isn't what they used to be.

One example of a misuse of such statutes came from an agent. The agent's email stated, “This morning, an underwriter told me he can cancel the policy of one of my contractors because they are going to do work in 'downstate' New York, and his company doesn't want to insure work in that area." While this may be a carrier underwriting guideline, this is not a material change in operations. They wrote a contractor that did “X," and they are still doing “X," they are just doing it in an area the company may not like. They do have the option to non-renew, but no statue says anything about allowing mid-term cancellation when a risk falls outside of underwriting guidelines.

If the insured did “X" when the policy was written, but now does “X" and “Y," or changed completely to “Y" (with “Y" being a material or substantial change in operations), then the carrier has the statutory right to cancel mid-term. It's about what the insured does.

Don't let carriers bully you or the client with the threat. The carrier has the responsibility to prove the substantial or material increase or change in the risk insured. If it appears they overstep the bounds of the statute, recommend a joint call with the department of insurance, you may be surprised by the results.

Last Updated: June 21, 2019

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