The law of agency: the insurer as principal and express, implied, and apparent authority

Why agency law matters to a producer

An insurance company is a corporation. It cannot shake hands, take an application or hand over a policy by itself. It acts through people, and the body of law that decides when those people's words and acts bind the company is the law of agency. Every time a producer quotes a rate, collects a premium or promises coverage, agency law answers one question: is the insurer now on the hook?

The three parties

• Principal. The person who authorizes another to act for it. For an insurance agent, the principal is the insurer.
• Agent. The person authorized to act on the principal's behalf. In insurance this is the producer appointed by the company.
• Third party. The person the agent deals with on the principal's behalf: the applicant or insured.

The relationship is usually created by an agency contract (the appointment or producer agreement) between the insurer and the producer. A core rule follows from it: within the scope of the agent's authority, the acts of the agent are the acts of the principal. Knowledge the agent acquires while acting for the insurer is generally treated as knowledge of the insurer, too. If the agent knows a fact about the risk, the insurer is presumed to know it.

Contrast this with an insurance broker, who acts on behalf of the insured, not the insurer, when placing coverage. New York's definition of an insurance broker describes someone who acts "on behalf of an insured other than himself." The broker's principal is the client. The agent's principal is the company.

The three kinds of authority

Express authority is the authority the principal actually and deliberately grants, usually in writing in the agency contract. Examples are the lines the agent may sell, the territory, whether the agent may bind coverage and up to what limits, and whether the agent may collect initial premiums. A written binding-authority agreement is a textbook example. New York's excess line law, for instance, defines an "authority to bind coverage" as the written agreement that sets out "the terms, conditions, and limitations" governing a broker's binding authority.

Implied authority is authority that is not written down but is reasonably necessary to carry out the express authority. It flows from the express grant. If the contract authorizes the agent to solicit and take applications, the agent impliedly has authority to hand out brochures, explain the policy, arrange a medical exam or inspection, and deliver the policy. Implied authority is still actual authority: the principal is understood to have intended it.

Apparent authority (also called ostensible authority, or authority by estoppel) is the appearance of authority that the principal's own conduct creates in the mind of a reasonable third party, even though no actual authority exists. It has three elements: (1) the principal did or allowed something, (2) a third party reasonably relied on it, and (3) the third party would be harmed if the principal could deny it. The insurer is then estopped from denying the authority. Classic exam examples:

• An insurer terminates an agent but lets the agent keep its applications, forms, rate books and signage, and a customer pays a premium to that agent.
• An insurer repeatedly accepts business the agent bound beyond its written limits without objecting, so customers reasonably believe the agent can bind those limits.

Apparent authority comes from the principal's words or conduct, never from the agent's own claims alone. An agent cannot create authority by bragging about it.

When the agent goes beyond authority

If an agent acts outside all three kinds of authority, the insurer is generally not bound, unless it later ratifies the act. Ratification means approving the unauthorized act after the fact, for example by accepting and keeping the premium on a policy the agent had no authority to bind. Ratification makes the act binding as though it had been authorized from the start. An agent who exceeds authority can be personally liable to the insurer or the insured, which is one reason producers carry errors and omissions (E&O) insurance.

The agent's duties to the principal

The agent owes the insurer fiduciary duties: loyalty, obedience to lawful instructions, reasonable care and skill, and a duty to account for money and property. New York writes the money duty into statute. Every insurance agent and broker is responsible "in a fiduciary capacity" for all funds received as agent or broker, and may not commingle those funds with his or her own without the principal's express consent. A separate bank account for each principal is not required, as long as each principal's funds are reasonably ascertainable from the producer's books.

The exam pattern

When a question describes a producer's act, ask in order: Was it written into the contract (express)? Was it reasonably necessary to do what was written (implied)? Did the insurer's conduct lead the customer to reasonably believe it was authorized (apparent)? If any answer is yes, the insurer is bound. If all are no, the insurer is bound only if it ratifies.