Professional liability insurance is vital for financial professionals. This type of insurance (also called errors & omissions or E&O insurance) protects you and your firm from potential client lawsuits. If clients are dissatisfied with your services, they may decide to file a lawsuit. Their claim can be based on many different issues. A client might say that your company was negligent in filing paperwork on time. They could also claim that you did not take the necessary precautions to keep their information private. If you manage money for a client, they may sue you for investment losses that they incur based upon your recommendations.
Professional liability insurance ensures that your business is financially protected against these lawsuits. This helps you avoid paying for legal fees and court judgments, saving you time and money. If you do become embroiled in a legal battle, professional liability insurance can cover your legal fees or settlements.
Even with the best intentions, mistakes can happen in the workplace. Misfiled, erroneous, or tardy documents can all subject your company to a lawsuit. Clients may also sue if they think you have failed to exercise adequate professional judgment. Other openings for lawsuits include perceived conflicts of interest or deviations from legal agreements. In short, any perceived failure by your company that leads to financial losses for a client can be grounds for a claim.
Regardless of whether your company is at fault, these claims can cause a world of trouble. They may cause your firm’s reputation to suffer and result in lost clients. They can also take up time and money, causing your productivity to suffer. In short, even if your company wins a lawsuit, being sued can still cause irreparable damage.
Professional liability insurance is not mandated by law in most states. This means that your firm can choose whether to put it in place. However, having the right professional liability insurance can provide protection and peace of mind in the event that your financial services firm is sued.
What Does Professional Liability Insurance Cover?
Most professional liability insurance policies for financial professionals provide similar basic coverage. However, insurance policies vary from provider to provider so it is important to read your policy carefully or consult with your broker or insurance advisor.
Some common policy coverages for financial professionals may include:
Claims of professional errors protect financial professionals if their client claims they made a damaging error on their paperwork or while handling their business. This can be a perceived error or an accidental one.
Claims of negligence in providing services occur when a client accuses a financial professional of not doing thorough research or performing their duties fully, with resulting damage. This might apply to a tax preparer who unknowingly files a client’s tax return with incorrect information. A lawsuit would claim they should have been more careful in verifying the information.
Breach of duty is a claim regarding financial professionals who act in their client’s interest as a person of trust. This might be as an investment advisor or financial advisor, for example. Claims related to breach of duty would accuse the professional of neglecting to carry out their duties to an acceptable standard, such as misusing client funds.
Misleading statements refer to cases where a financial professional gives advice that misleads a client. If the client follows the advice as they understand it and suffers financially, they can file a claim that their adviser misled them. For example, if your firm promised a client that an investment had no fees, but the investment actually had substantial hidden fees, the client might sue you for misleading statements.
Claims related to performance mean that a client was unsatisfied with the level of professional services they received. For example, if an investment you recommended performs poorly, a client may sue you for losses.
There are several common exclusions from professional liability coverage. These may include but are not limited to:
- Malicious, illegal, or deceptive acts
- This includes any intentional law-breaking or violation of statutes and ordinances
- Services provided under another business’ or organization’s name that are not named in your insurance policy
- Liability for damages against any other insured party on your policy
- Liability insurance also does not provide coverage if damages are done on behalf of these parties. If your institution is sued by a person or institution that is also on your policy, the policy will not cover your institution’s liability.
- Copyright infringement
- Bodily harm or death of a person
- There may be coverage offered in general liability coverage
- Damaged property or loss of use because of damage
- General liability insurance may cover this
- Slander and libel
- Wrongful entry, eviction, invasion of privacy, imprisonment, and malicious prosecution
- Illegal discrimination, punitive fines, pollution, violation of securities law, and insolvency
Limit of Liability
The limit of liability is the most that your insurance company agrees to pay for damages, settlements, and legal fees if a claim occurs. You can choose the limit of liability for your policy within limits set by the insurance company. Your insurance premiums will be higher with higher limits of liability and vice-versa.
Most often, limits of liability are outlined both as per claim and in aggregate. Per claim means that a single claim will have a specified maximum coverage. An aggregate limit is the amount your insurance company is willing to pay in a policy year for all claims during that year. For example, if you have limits of liability of $2 million per claim/$5 million per year, the insurance company will pay up to $2 million for any single claim and will pay a maximum of $5 million for all claims during the year.
The majority of policies include the cost of legal defense fees within your limits of liability. This means that any legal fees due to defending against claims come out of your limit of liability. Legal fees subtract from the amount left to settle out of court or pay fines leveled against your firm.
This is because many claims are dismissed out of hand or have small settlements. Even claims that end in judgments against you are likely to cost only part of your coverage. It is common for a legal defense to cost more than settling a claim or paying as a result of a judgment.
You can choose your policy deductible while purchasing a professional liability policy. A deductible is how much your firm is responsible for paying before your policy kicks in when a claim occurs. Deductibles are insurance companies’ way of sharing risk with those they cover. Having a deductible gives your firm a financial incentive to avoid claims.
Depending on your insurance provider, you will have a variety of options for your deductible. Often, deductibles range from small amounts up to $100,000. The higher your deductible, the lower your premiums will be.
For example, if your policy has a deductible of $50,000, and your business settles a lawsuit for $250,000, your company will be responsible for paying $50,000, and the insurance company will pay the remaining $200,000.
Professional liability insurance for financial professionals is a claims-made policy. With a claims-made policy, the insurance that provides coverage when the claim is filed covers the claim itself. The policy that was active when the events that caused the claim took place does not provide coverage.
To illustrate how a claims-made policy works, consider the following example. Your firm has a claims-made policy covering the calendar year 2018, as well as policies for each of the years 2015, 2016, and 2017. You have a former client whose finances you managed from 2015–2017. In March 2018, this client sues your firm alleging professional negligence. The insurance policy that covers the claim will be the policy from the year 2018 because that is the year that the claim was filed, even though the work was performed in prior years.
Professional liability claims often result from several events rather than one event. This makes claims-made policies necessary.
Claims-made policies provide no coverage for claims made after the policy ends. This applies even if a claim is later made resulting from work you did when you had active coverage. Canceling a claims-made policy means you lose coverage for all past work.
Retroactive Dates on Insurance Policies
Most professional liability policies have retroactive dates. Retroactive dates on policies further add protection to your professional liability coverage. Any work your institution performed between the retroactive date and date your policy begins is covered. Work done before the retroactive date is not covered, regardless of whether claims are made when you have the policy.
For example, if you have a professional liability policy with a retroactive date of Jan. 1, 2015, you would be covered for any claim caused by work that you did on Jan. 1, 2015, or later. However, claims for work performed in 2014 or earlier would not be covered, even if your claims-made professional liability policy is currently active.
Extended Reporting Period
Often, policies will have extended reporting periods at no extra cost. These periods are usually between three and six months. Extended reporting periods mean you have more time to report claims from when your policy was valid.
For example, if you have a policy that ends on Dec. 31, 2017 with a six-month extended reporting period, if you are sued before June 30, 2018 for financial advice that you gave before Dec. 31, 2017, that work will be covered by your claims-made policy.
Some policies offer the chance to buy an even longer extended reporting period in exchange for a premium. This premium is usually a percentage of the expiring coverage’s premium. Some insurance companies also offer unlimited reporting periods. This is known as “buying out the tail.”
Switching Insurance Providers
Always make sure that coverage continues without interruption whenever you switch insurance providers. If you start a new policy, it is best to make sure your new provider covers your previous work. This means that your retroactive date will be the same date as on your previous policy.
Sometimes, providers are not willing to use this retroactive date. This means you must buy an unlimited reporting period from another provider. Failing to do this means losing coverage for any work you did before your new policy takes effect. This leaves you liable for claims.
If you plan to retire or close your firm, you must buy an unlimited reporting period from a provider. If you do not buy out the tail when you retire, you will be liable for any work you did before you retired. If you retire but your firm keeps its liability coverage active, you will have the protection of that policy as long as it is active.
Applying for Professional Liability Insurance
When you apply for professional liability insurance, prepare to disclose any situations that could lead to a claim. Even if none of these situations have led to a lawsuit yet, your provider should know about them. This ensures that if a claim is filed based on one of these issues, your institution will be covered for it. Neglecting to disclose potential problems could lead to the insurance company rejecting your claims if you are sued.
For claims to be valid under your policy, you will need to have an active policy. In the event of a claim, notice must be given to the insurer promptly. The event causing the claim must have happened after the retroactive date on the policy.
Tell your insurance provider about any situations that can lead to potential claims as soon as you’re aware of them. This allows them to help resolve claims before more damages occur. Do not avoid reporting claims early to keep your premiums from increasing. Reporting claims does not in itself raise your premiums automatically. Reporting potential claims lets your insurance provider help prevent problems before they happen.
For financial professionals, the price of professional liability insurance is based upon the risk of the firm. The risk is measured by the type of financial advice or expertise being given, the firm’s revenue, geographic location, number of practitioners and employees, type of clientele, and number of claims.
How to Reduce Risk
Professional liability insurance, while vital for firms, is only one way to reduce the risk of claims. Make sure that you choose clients wisely and understand their intentions. Outline what services you can provide. Avoiding clients that seem impossible to please is a prime way to avoid claims.
As mentioned above, communicate with clients. Many claims occur because of miscommunication between financial professionals and their clients. Make sure that you communicate on a regular basis with clients and ensure you are on the same page. Checking in on a regular basis helps clarify issues before they snowball.
A set period of every 30 days is common, but more often is also helpful. This is true regardless of whether anything has changed in the status of a case. Make sure to document your communications with clients, too.
Finally, many claims occur because of missed deadlines or late paperwork. Many financial firms use software that is designed to keep track of deadlines. These software packages are worth their cost in avoiding claims due to preventable mistakes.