[INSIDER TIPS] Professional Liability Insurance AKA Errors and Omissions

Professional Liability Insurance, also known as Errors and Omissions, provides coverage to a policyholder for a “wrongful act”.  

A "wrongful act" is insurance jargon for giving the wrong opinion or forgetting to give a customer or client the right information or service.

What Does "Claims Made" mean?

The coverage is typically written in a “Claims Made” policy format, which requires the policyholder to have continuous coverage throughout their career.   

The first policy ever purchased will establish what is commonly referred to as a “retro date” on the first day the policy goes into effect.  

As long as the policyholder maintains continuous coverage, without lapse, then all claims made against the policy holder will be honored from that date forth.

The Retro Date becomes increasingly more valuable as time goes on.  If a professional has a 30 year career, then the retro date can stretch back to the very first policy they purchased.

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File Personal Liability Insurance Claims Promptly

I’ve heard horror stories over the years, where a professional is trying to do the right thing with their client and make things right.  

But in the end the client hires an attorney and sues the Professional.

The insurance company has the right to deny coverage if they are not “put on notice” promptly.  

This becomes very important at renewal.  Once a policy expires, the policyholder will only have 30 to 60 days to file a notice of claim on any wrongful act that they were aware of during the policy term.  

Being “aware” of the claim situation is the key to this pitfall.  

The time clock begins as soon as the professional is aware of the potential for the situation to become a claim.

Unlike other business insurance policies, it is best to put an insurance company on notice of a potential claim.  

That way, the policyholder can retain their ability to file a claim in the future.  

Who Needs a Professional Liability Policy?

The short answer:  Anyone who is paid to render their opinion.

Professional Liability Insurance is a business insurance typically carried by:

It can also be secured by construction companies, who may be drawn into litigation due to poorly designed building plans.  

Hair Stylists and Consultants may also carry the coverage.  

Anyone who is paid to render their opinion as an expert in a field should consider buying a professional liability policy policy since your opinion is being relied upon by others to guide their actions.  

Don't make the mistake of thinking a business owners policy will cover you in these matters, because it won't! 

If that opinion is wrong or if the professional fails to perform their professional duty, then the customer or client of the professional may suffer a financial loss.  

This loss will turn into an insurance claim.

What is Included in an Errors and Omissions Policy?

Many professionals may only need a lawyer to defend them in a frivolous lawsuit.

The defense cost feature of this policy is very important.

Defense Costs Erode the policy limit?

The majority of Professional Liability Insurance policies on the market today have defense costs “inside the limit” of insurance.

That means the lawyer fees eat away at the total amount of coverage available to pay a claim.

You have a $1,000,000 limit of coverage and the lawyer cost $450,000 to defend the claim? 

 You have the remaining $550,000 to pay on the settlement (minus the deductible).

Watch Out For The 'Hammer Clause'! 

Sometimes, an insurance company claims adjuster can negotiate a settlement with a claimant very quickly, at a dollar amount he feels to be fair and reasonable.

Professional Liability policies require the insured professional to sign off on any claim settlement before the adjuster can finalize with the injured party.

“I’m Not Guilty!”

In some cases, the professional may not agree that he is guilty of the alleged offense. 

Since his approval is required before a settlement can be reached, the court battle may continue for much longer.  

These court cases can cause the insurance company to pay a lot more in attorney fees representing their client against the plaintiff.

Enter, the Hammer Clause!

This is a cute way insurance people refer to the clause within a policy that outlines how the claim will be handled once the adjuster and the claimant have reached an initial settlement agreement. 

The clause usually says the insurance company will only pay for a lower percentage of the legal fees after they reach an initial settlement agreement with the claimant. 

This gives the professional some “skin in the game” after the first settlement offer is agreed upon.  

It gently encourages the insured professional to agree to the first settlement by forcing them to help pay for the attorney to represent them moving forward.

You may be wondering, “why would the insured professional withhold his consent to settle?”

Your Reputation is at Risk

In the professional world, reputation is everything.  A settlement must be accepted by the plaintiff’s party, as well as the insured policyholder.  

If the policyholder withholds their consent to accept the settlement, the insurance company will have to go back and continue to negotiate with the plaintiff.

The insurance companies have built in a “Hammer Clause” to the policy contract, which is meant to encourage the policyholder to a quick settlement if the plaintiff’s party agrees to one.

After a Settlement Offer...You are on the HOOK

The Hammer Clause states that the policyholder will be on the hook for a percentage of the legal fees associated with pursuing the claim further once a settlement has been accepted by the plaintiff.  

Some policies even require the policyholder to share in the additional settlement amount paid if they refuse to accept the first negotiated settlement amount.  

Since there is so much variety in Hammer Clauses, a policy holder should obtain a sample copy of the policy they are considering prior to binding coverage, so they can review the Hammer Clause.

Adding an Extended Reporting Period, AKA “Tail Coverage”

A unique problem arises when a professional sells his practice or retires.  

Professional Liability policies require the insured professional to have a policy in force at the time of a claim.  

As time goes by, the probability of a claim occurring diminishes.  Most states have a statute of limitations as well, so the professional is not eternally liable for acts they commit in their professional lives.

The way the insurance industry has bridged the gap in time between sale of the practice and the expiration of the statute of limitations is by offering to sell an extended reporting period on an expiring policy to the insured professional.

The extended reporting period is known as adding “tail coverage” in the insurance business.

Tail coverage allows a professional who is retiring or selling the business to still maintain the ability to file a claim against a policy that is no longer in force.  

As we mentioned above, Professional Liability insurance policies typically must be in force when the “wrongful act” occurred, as well as when the claim is filed.

Why an Extended Reporting period is Important

Buying a tail allows the policyholder to extend coverage past the expiration date of the last policy purchased for up to three years.

Premiums are typically 100% of the normal policy premium for a one year tail… 200% of the normal policy premium for a two year tail… and 300% of the normal annual policy premium for a three year tail.

So if your policy normally costs $1,000 a year and you want to add a three year tail, the additional premium is $3,000.

This island is also home to a small airfield.  

Tom entered into a contract with the state of Massachusetts and provides his professional opinion of the location being adequately distant from the location of the airfield.

A few years later, Tom decides to retire.

At retirement, Tom sells his business to another engineering firm.  

He also picks up three years of tail coverage, which allows him to meet his contractual obligation to the state of Massachusetts for his work on the cell tower.

One day, the power fails to the cell tower and the warning lights installed on it fail.  

A small aircraft, who missed the runaway on his first attempt banks to make another pass and because the lights on the tower were dark, he runs right into it and he is killed in the plane crash.

Tom was able to file a claim against his expired Professional Liability policy for defense costs related to these allegations the deceased pilot’s family brought against him and the state of Massachusetts because he had purchased the additional claims reporting period, otherwise known as “tail coverage” in the insurance industry. 

How to Buy Professional Liability

This is a very complex policy.  Its best to work with an insurance expert when securing coverage.  

Finding an insurance agent who specializes in E&O (Professional Liability) and can shop the market for the best pricing is a savvy move.  

An independent agent will have market access and have the ability to explain a complex policy to you.  

They can also help during the claims process.  A professional insurance agent will have years of experience with claims.  

They will guide you through the process.

Don’t Mess Up the Application

When buying a Professional Liability policy, it is very important to accurately fill out the application.  

More so than in other types of Commercial Insurance, Professional Liability coverage is triggered by the statements made within the application.

Your agent should know this truth, if they don’t, it is a red flag.  You should consider using a new agent.

Main Takeaways Before You Buy E&O Insurance

Anyone who is paid to render their professional opinion to others in exchange for payment should carry some professional liability insurance. 

Limits as low as $500,000 are available. Deductible options range from $0 to as much as $25,000.  

High deductibles are appealing due to the lower up front cost they provide to the policyholder.

Be careful with claims

Just putting an insurance company on notice of a potential claim in the future will reserve your rights to coverage should the need arise.

Be careful with your application

The application becomes a part of the policy.  Coverage is triggered by what you define as your “professional service” within the application.  

Committing a “wrongful act” in the course of performing your “professional service” is what triggers coverage.

Be careful when you sell the practice

Buy an extended reporting period.  If you are a part of a group and are retiring, ask the person in charge of the insurance what the extended reporting period is on the group policy.  

May the odds always be on your side!