Who Needs Errors and Omissions Liability Coverage?

Serious businessman working at laptop in office
E&O Insurance Covers Claims of Negligence or Failing to Provide Level of Service Expectations. Getty Images/Hero Images

Errors and omissions liability insurance (or E&O insurance for short) covers claims that arise from your negligent acts or your failure to provide the level of advice or service that was expected. It is also called professional liability insurance.

The word professional is often associated with lawyers, bankers, physicians and others who require extensive education to perform their duties. Yet, you need not be a doctor or lawyer to have a professional liability exposure.

Virtually any business that performs a service or provides advice to others in exchange for a fee could be sued on the basis that it failed to fulfill its professional obligations. Here is an example.

Sample E&O Scenario

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

Peter is shocked when he receives notice of a lawsuit against his company. The plaintiff is Harry’s Hardware, a small chain of hardware stores. Harry's hired Peerless Programming to create an inventory management and tracking system. Peerless completed the system and installed it at the hardware chain six months ago. Harry’s has now filed a lawsuit claiming that the program cannot be used because it is full of bugs.

The suit 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 damages.

Harry’s lawsuit is unlikely to be covered under Peerless Programming’s general liability policy. For one thing, the lawsuit does not seek damages for bodily injury, property damage or personal and advertising injury.

Moreover, the injury alleged (financial loss) was not caused by an occurrence, as that term is defined in the standard liability policy. With no coverage for the lawsuit under its general liability policy and no errors and omissions coverage, Peerless may be stuck with a large out-of-pocket expense. This may include money it has to pay as damages or a settlement as well as any legal expenses it incurs.

Common Features of E&O Policy

If you are a “traditional professional” like a physician or attorney, you may obtain errors and omissions coverage under a policy form that is specific to your profession. For instance, an attorney will likely be insured under a lawyer’s professional liability policy. If you are a “non-traditional professional” like a consultant or real estate broker, your coverage may be written on a nonspecific policy form called a miscellaneous professional liability policy.

There is no standard E&O policy, so policy forms may vary considerably from one to the next. Yet,  E&O policies do have certain features in common.

Claims-made

Most errors and omissions policies are claims-made. This means that they limit coverage to claims made during the policy period. Some policies also limit coverage to claims reported during the policy period.

Many E&O policies specify a retroactive date in the declarations. This should be the inception date of your first claims-made E&O policy. If a retroactive date is listed, then your policy will cover a claim only if it results from an act, error or omission that was committed on or after that date. The retroactive date should remain the same each time your policy is renewed.

Insuring Agreement

The coverage your policy provides is summarized 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 for which you are covered. Make sure that the description accurately reflects the services you provide.

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 specific policy terms, defense costs may or may not reduce the policy limits. The cost of defending claims can be substantial. Thus, look for a policy that covers defense outside the limits.

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 
  • Fee disputes
  • Profits you have gained illegally 
  • Failure to maintain insurance

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

Limits and Retention

Most E&O policies contain a limit that applies to each claim. This limit is the most the insurer will pay for damages or settlements arising out of a single claim. The policy may also contain an Aggregate limit. This is the most the insurer will pay for all damages or settlements arising out of all claims combined. If defense costs are subject to the limits, the each Claim and Aggregate limits will include defense costs as well.

Some E&O policies include a retention. A retention is a type of deductible. It is the amount you must pay out of pocket for each claim before your insurance will apply.