On May 24, 2018, the U.S. Senate passed a bipartisan bill to change the way Congress handles sexual harassment claims on Capitol Hill. The bill, which is still in reconciliation, would streamline the process for filing sexual harassment complaints against members of Congress and their offices and make lawmakers personally liable for settling claims. The legislation is just one example of a recent shift in the climate surrounding sexual harassment. Public attention from U.S. athletes and celebrities and movements like #MeToo and #TimesUp have drawn increased awareness of — and action around — sexual harassment.

As employers work to improve existing sexual harassment training and policies, they continue to find themselves dealing with the repercussions of past incidents, often through lawsuits or insurance claims that are typically covered under their employment practices liability policies.

EPL policies provide employers with liability insurance covering wrongful acts arising from the employment process, one of the most common of which is sexual harassment.

When pricing for an EPL policy, actuaries typically use historical claims experience to predict the emergence of claims in the future. Similarly, actuaries estimate incurred but not reported reserves on existing claims to account for growth in the claim value expected above that contemplated in the claims adjusters’ case reserves. To the extent that trends in claim frequency and severity are changing, the historical claims experience may no longer be an accurate predictor of future claims experience. It is essential for companies writing these policies to consider this level of uncertainty in their estimates.

Changing legislation

Legislative changes also introduce a level of uncertainty to claims that may affect pricing and reserving moving forward. In Minnesota, for example, a proposed state constitutional amendment would redefine sexual harassment as creating an “intimidating, hostile, or offensive environment,” but would no longer require the conduct to be “severe or pervasive.” The proposed amendment may ease constraints on victims, but may also create ambiguity regarding the definition of sexual harassment.

Similarly in Michigan, a 2018 law, extends the statute of limitations on those who were sexually abused as children. The legislation has engendered opposition from governmental entities and businesses that are concerned by the effect that the extended statutes will have on claim volume.

In California, two bills in the state Senate would address the prevention of sexual harassment in the workplace and soften restrictions on employees who have experienced sexual harassment. S.B. 820, which has passed the state Senate and has moved on to the state Assembly, puts restrictions on nondisclosure provisions in settlement agreements related to sexual assault or harassment. The change to nondisclosure agreements could significantly increase the reputational risk to employers. Meanwhile, S.B. 1300 would prohibit employers from denying employees the right to disclose information about unlawful acts in the workplace, including sexual harassment. S.B. 1300 also increases certain sexual harassment training requirements.

Coverage and prevention

Although EPL coverage can provide an effective way to mitigate this liability, it is also important for companies to establish preventive measures against sexual harassment in the workplace. For example, some companies have emphasized bystander training, which encourages bystanders to intervene or disrupt a potentially hostile situation, and promotes open dialogue between bystanders and targets of harassment.

Now more than ever, companies must find the right balance of coverage and retention limits as well as establish a plan and budget for prevention — including sexual harassment training, policy establishment and enforcement. Too much money spent on EPL coverage and not enough effort toward prevention can cause a variety of problems, the most obvious of which is the volume of claims that may arise if an employer appears to tolerate sexual harassment in the workplace. A lack of prevention efforts can also damage a company’s reputation because it may appear that the employer is neglecting employees’ well-being.

Conversely, insufficient spending on EPL coverage could have significant adverse effects on employers. Despite efforts to improve current workplace conditions and procedures, a company is still responsible for past incidents, many of which may take years to report. As companies work to improve training on sexual harassment, it will take time to determine the most effective programs and to see the long-term effect on EPL claims experience.

Underestimating the amount of EPL coverage needed could inundate a midsize company, which may not have the capital to withstand a significant influx of EPL claims. For companies purchasing commercial insurance, adverse experience may cause their rates to jump or their insurer to deny coverage. For companies that self-insure this exposure, when actual experience exceeds funding contributions, a company will be left paying those excess costs out of its operating budget or capital.

Effective risk management is key in maintaining a successful insurance program. Insurers offering EPL coverage often establish incentives for employers to develop effective prevention methods through use of a deductible or self-insured retention. Careful consideration of coverage terms and retention limits is necessary in developing the appropriate insurance program for companies’ EPL exposure.

Coverage considerations

With the evolving climate, it is essential for employers to closely monitor their EPL coverage. The recent societal and political conditions have led not only to an increase in frequency, but also to a shift in the severity of EPL claims.

Policyholders may begin to see shifts in premium rates resulting from this evolving legal environment. A thorough review of a company’s elected coverage, including any exclusions in its policy, is helpful in establishing effective corporate sexual harassment policies. Companies that establish their own funding or reserves for EPL claims must carefully consider how to adjust their methodology to keep pace with the evolving nature of the coverage.

It is important for companies to consider the increased uncertainty when making decisions on funding and reserving levels — for example, funding or reserving to a higher probability level. By judgmentally selecting frequency and severity distributions and associated parameters, actuaries can generate countless simulations of aggregate claims experience to determine the likelihood of exceeding certain funding and reserving levels. For example, at the 65th percentile probability level, the actuary expects that the funding or reserve levels will be adequate for 65% of the simulated scenarios; at the 95th percentile probability level, the actuary expects that the funding or reserve levels will be adequate for 95% of the simulated scenarios. If a company wants increased confidence that the amounts it is funding or reserving will be adequate to cover any adverse experience, it may choose to book to a higher probability level.

When recent claims experience develops differently than historical experience would have indicated, it is vital for companies to consider the implications of this change on the current funding and reserve provisions for their EPL coverage. The most common actuarial methods are based on the general assumption that “history will repeat itself” or, specifically, that historical claims experience is indicative of future claims experience. In the case of sexual harassment, the efforts of many are aimed at organizational and legislative changes in hopes that, in this case, history will not continue to repeat itself.

This article was originally published in the August edition of Business Insurance.