Who Needs Errors and Omissions Liability Coverage?

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Errors and omissions insurance (or E&O insurance for short) is a type of commercial liability coverage. It protects your business against claims arising from your negligent acts or your failure to provide the level of advice or service the plaintiff expected. E&O coverage is also called professional liability or malpractice insurance.

Business professionals like architects, physicians, and computer consultants hold themselves out as experts in their field.

These individuals are expected to meet the standards of care that prevail in their industry. The standards vary by professional. In many industries, professionals are expected to act like a reasonable person in a similar situation with equivalent education and experience.

Virtually any business that performs a service or provides advice in exchange for a fee may have a professional liability exposure. Here is an example.

Sample E&O Scenario

Peter owns Peerless Programming, a small company that provides computer programming services to businesses. Peerless develops software programs that are customized for each client. The company is insured for liability under a standard ISO general liability policy. Peerless does not have errors and omissions liability coverage.

About a year ago, Peerless Programming was hired to create an inventory management and tracking system for Harry’s Hardware, a small chain of hardware stores.

Peerless created the system and installed it in the stores. The work was completed six months ago. Now Harry's Hardware has sued Peter's firm. The lawsuit claims that the computer program Peerless created is unusable because it is full of bugs. It also alleges that Peerless failed to adequately test the program and that its negligence has cost Harry’s thousands of dollars in lost work time.

Harry's seeks $100,000 in compensatory damages.

Harry’s lawsuit is unlikely to be covered under Peerless Programming’s general liability policy. For one thing, Harry's alleged injury is a financial loss. The company is not seeking damages for bodily injury, property damage or personal and advertising injury. Moreover, the injury was not caused by an occurrence as that term is defined in the liability policy. With no coverage for the lawsuit under its general liability policy and no errors and omissions coverage, Peerless will be stuck paying the damages or a settlement out of pocket. It will also have to pay whatever legal expenses it incurs.

Types of E&O Policies

Many E&O policies are tailored to specific types of professionals. For example, architects and engineers E&O policies are intended for design professionals. Likewise, lawyers professional policies are designed for attorneys, and dental malpractice policies are intended for dentists. If an industry-specific form isn't available, an insurer may provide E&O coverage using a miscellaneous professional liability policy. This non-specific E&O policy form is often used to insure "non-traditional" professionals like consultants, travel agents, and construction managers.

Common Features of E&O Policies

E&O coverage forms are not standardized so they vary from one type to another, and from one insurer to the next. Nevertheless, the policies have many common features.

Claims-Made

Most errors and omissions policies are claims-made, meaning they cover claims made during the policy period. For a claim to be covered, it must be made against an insured during the term of the policy.

Some policies limit coverage to claims made and reported during the policy period. This means that claims are covered only if they are made against an insured and reported to the insurer during the term of the policy.

Many E&O policies specify a retroactive date. If a retroactive date is listed in your policy declarations, your policy covers claims resulting from acts, errors or omissions committed on or after that date.

Claims resulting from errors or omissions committed before the retroactive date are not covered. The retroactive date should be the inception date of your first claims-made E&O policy. It should remain the same each time your policy is renewed.

Insuring Agreement

The coverage your policy provides is described in the insuring agreement. This clause typically begins with the words “We will pay". The insuring agreement is a statement outlining what the insurer promises to do in exchange for the premium. A typical E&O insuring agreement states something like this:

"We will pay on behalf of the insured loss that the insured becomes legally obligated to pay for any claim first made during the policy period that arises out of a wrongful act."

This means that the insurer will pay damages or a settlement that you are required to pay because of a claim based on a wrongful act.The words "pay on behalf" mean that your insurer will pay these costs upfront rather than reimbursing you.

The term wrongful act usually means a negligent act, error or omission that you allegedly committed while performing or failing to perform professional services. Professional services may be defined in the policy definitions. Alternatively, the type of services covered may be described in the declarations. An example is "software consulting services." The description of covered services is important because it determines the types of activities that are covered by your policy. Make sure that the description accurately reflects the services your business provides.

Defense

One of the most important coverages included in an E&O policy is defense coverage. The policy should state that the insurer will defend you against covered claims. If defense is not covered, you will be stuck paying defense expenses out of your pocket. Depending on the policy, defense costs may be covered inside or outside the limit. The cost of defending claims can be substantial. Thus, a policy that covers defense outside the limits affords better protection.

Exclusions

Like all insurance policies, E&O forms contain exclusions.  Here are some exclusions that are commonly found in E&O policies.

  • Punitive damages
  • Dishonest, fraudulent or criminal acts committed by you or another insured
  • Wrongful acts you were aware of before the policy inception date
  • Wrongful acts or claims you reported under a previous policy
  • Bodily injury or property damage 
  • Liability assumed under a contract
  • Fee disputes
  • Profits you have gained illegally 
  • Failure to maintain insurance
  • Discrimination based on race, sex, color, creed, etc.
  • Pollution

This is not a complete list. Your policy is likely to include additional exclusions.

Limits and Retention

Many E&O policies contain an individual limit and an aggregate limit. The individual limit may apply to each claim or to each wrongful act. It represents the most the insurer will pay for damages or settlements arising out of a single claim or wrongful act. The aggregate limit is the most the insurer will pay for all damages or settlements arising out of all claims made during the policy period. If defense costs are subject to the limits, the individual and aggregate limits will include defense costs as well.

Some E&O policies include a retention, a type of deductible. The retention is the amount you must pay out of pocket for each claim. Depending on the policy, the retention may apply to damages only or to damages and claims expenses.