ABA Section of Business Law
ABA Section of Business Law
Business Law Today
September/October 1999
Protecting the professional
Brush up on E&O insurance
By DAVID A. BAUGH and ELLEN L. FLANNIGAN
Baugh and Flannigan are partners at Mora & Baugh, Ltd. in Chicago.
Though the two words seem contradictory, professionals can make mistakes. They need protection. So what we have here is a brief overview of the different types of insurance available with a specific emphasis on errors and omissions insurance coverage.
Several variations of liability insurance are out there for today’s professionals. The type of insurance depends on the type of coverage required. Seldom do these policies provide overlapping coverage.
One is commercial general liability (CGL) insurance. This provides coverage for bodily injury or property damage caused by an event that has been defined as an unintentional or accidental act on the part of the insured. For example, if a customer falls down and sustains bodily injury, CGL insurance would cover this loss. CGL insurance, however, does not cover injuries or damages as a result of the rendering of professional services.
Another is workers’ compensation insurance, which provides coverage for bodily injuries sustained by employees that arise out of, and occur during, the course of their employment. For example, if an employee is injured while operating a piece of machinery owned by the business, workers’ comp insurance pays the injured employee benefits such as medical expenses and lost wages following the state workers’ compensation scheme. Again, it does not provide coverage for injuries or damages as a result of the rendering of professional services.
Then there is directors and officers liability insurance. It provides coverage of claims made against directors or officers of the corporation based on wrongful acts performed in the person’s official capacity. For example, a director or officer may be held civilly liable for mismanagement that causes the corporation’s stock price to fall or is charged with self-dealing. D&O insurance does not provide coverage for the business entity for bodily injury or workers compensation or for professional malpractice.
Professional liability insurance — or errors & omissions (E&O) insurance — is a type of coverage essential to every professional corporation. E&O insurance covers wrongful acts in rendering or failing to render professional services of an individual such as a doctor, an accountant, a lawyer or a professional business entity, such as an accounting firm, medical group or law firm. For example, should an accountant fail to detect embezzlement in an audit of its client, that accountant may be held civilly liable, as well as the firm that employed the accountant or, if a lawyer does not timely file a lawsuit, the lawyer or the employing firm could be held liable.
However, E&O insurance does not provide coverage for employment-related claims such as employment discrimination or sexual harassment or business decisions or administrative actions. Unlike general liability insurance, which provides coverage for the corporate entity for bodily injury and property damage caused by its agents and employees, and D&O insurance, which provides coverage for claims made against directors and officers, E&O insurance provides coverage for the professional. Such coverage is of vital importance in today’s world since defending a lawsuit is a costly and typically unbudgeted expense, which could be the death-knell of a small professional entity or a sole practitioner.
When a professional or small business entity obtains its E&O policy, it should review the terms and conditions. Although reviewing an insurance policy can be daunting, it is pivotal for the insured to know and understand the policy terms and conditions to ensure that coverage for claims is provided.
E&O policies are specifically tailored for different professionals, such as doctors, architects, engineers, surveyors, lawyers, accountants, stockbrokers, insurance producers and real estate agents. As such, services typically provided by these professionals will be included in the definition of professional services. However, should the professional have an expertise (that is, a surgeon or a patent lawyer), those services should be specifically included. The insured should prefer to have this definition as broad as possible to cover any potential claims that may arise when rendering a professional service as the scope of services performed by various professionals continues to expand.
Insurance policies do not go on ad infinitum. Rather, they have "effective dates" in which they remain in effect. Careful attention needs to be paid to these dates to prevent a lapse of coverage or to prevent duplication of coverage. Typically, E&O policies should be renewed, and the premiums paid, prior to the expiration of the effective date to maintain coverage. Problems occur when a claim is made after the policy has lapsed and a renewal check has not been received by the insurer. In those cases, the insurer may deny coverage.
E&O insurance comes in two basic varieties. There are "occurrence" and "claims-made" policies. An occurrence policy provides coverage for acts or omissions committed by a professional during a policy period regardless of whether a claim is asserted during that period. For example, a doctor maintained an occurrence policy from 1993 through 1996, and a malpractice claim was filed in 1997 for services rendered in 1995. Even if the doctor elected to obtain coverage from a different carrier after the malpractice occurred in 1995, the occurrence policy’s coverage would be triggered.
Coverage under a "claims-made" policy generally is triggered by the assertion of a claim against the insured during the policy period regardless of when the malpractice occurred. Using the same example, a claim is made in 1997 for malpractice that occurred in 1995. The 1997 policy coverage would be triggered. As such, professionals with claims-made coverage should continue to purchase coverage with no coverage gap until any claim or potential claim is barred by the applicable statute of limitations. Claims-made coverage is the most widely used type of professional liability insurance coverage.
When a business or an individual professional completes an application for E&O insurance, disclosure must be made to the insurer of any and all claims or potential claims that have been made prior to the new policy or those potential claims that could be made during the effective date of the new policy. The insurer’s underwriting department will review these disclosures to either accept or exclude coverage. Disclosure of these claims or potential claims also affects the amount of premiums that may be charged.
If the insurer declines to accept the risk for the disclosed claims or potential claims that may arise based on conduct that occurred prior to the inception date of the policy, those claims will be specifically excluded under a "prior-acts" exclusion under the policy. This provision excludes from coverage all claims based on alleged acts, errors or omissions that predate the policy inception date. When a claim falls under the prior-acts exclusion, the insurer does not have a duty to defend or indemnify the insured for that loss.
Corporate loyalty is not what it used to be. No business, big or small, is immune. Seeking greener pastures, professionals now hop from job to job, corporation to corporation, and have set up their own businesses. As such, new E&O policies are obtained and the old policies have expired or are discontinued. If the prior employer had a claims-made policy, there is typically no coverage for a claim made against the employee who has since terminated his or her employment provided that the policy is discontinued and a successor policy is not purchased. As such, the professional is left unprotected.
To remedy this coverage gap, the insurance industry developed a safety net called "tail" coverage or "extended reporting period." Tail coverage is a specific type of insurance policy that provides coverage in the event that malpractice occurred during a prior policy, but a claim was not made until after the policy expired. Tail coverage is typically purchased when a professional leaves one employer and is employed by another or becomes self-employed.
It is imperative that when changing employment status, the professional meet with management concerning which type of malpractice coverage (that is, claims-made or occurrence) was provided. Typically, that professional can contact the same insurance company to obtain tail coverage. Or, alternatively, when purchasing a new insurance policy, tail coverage under the old policy may also be provided at additional cost.
More than one insurance policy may cover a claim. A policy for "excess insurance" can be purchased to cover claims that are made in excess of the primary policy’s coverage. For example, a primary policy may provide $500,000 and the excess policy provide for an additional $1,000 to $5 million in coverage. Coverage under excess policies is only triggered once the primary policy’s limits are met.
Also, on occasion, a professional may maintain his or her own malpractice insurance policy and also be covered by his employer’s E&O policy. For example, it is common for nurses to maintain their own malpractice insurance in addition to the hospital’s policy. Therefore, when a claim is made, careful attention should be paid to be sure that notice of the claim is sent to all insurance carriers. The two insurance companies will then determine which carrier is going to provide coverage. In case one carrier declines coverage, the prior notice of the claim to the other insurer prevents it from asserting that it did not receive timely notice of the claim.
In addition to prior-acts exclusions, several other claims are typically excluded in an E&O policy. For example, "intentional acts," "fraud" or "willful violation of statute" exclusions are almost always mentioned. These exclusions provide that such acts as embezzlement, intentional bodily harm, anti-trust violations and certain statutory violations or criminal violations such as felonies, are excluded from coverage. For example, if a lawyer absconds with a client’s money or an accountant embezzles from a client, such willful or intentional and fraudulent acts are excluded from coverage.
Another common type of excluded claim in an E&O policy is bodily injury. Bodily injury claims include criminal and tortious assault and battery. For example, coverage would not be afforded to an accountant who gets into a fist fight with a client.
Also typically excluded are employment-related claims. These include sexual harassment and employment discrimination. These claims are sometimes covered under a D&O policy or, alternatively, separately covered under an employment practices liability policy.
Another example of an excluded claim is one for punitive or trebled damages. In many states, insurance coverage for punitive damages is void against public policy. Thus, even if the E&O policy contains coverage for punitive damages, it may not be enforceable. However, there are some exceptions to this rule, such as when an employer may be held vicariously liable for punitive damages for the acts of its agent. In these cases, because of vicarious liability, punitive damages may be recovered under a policy, depending on the state of the wrongdoing. Therefore, because of the variation in state law and policy language, the insured should carefully review coverage provisions and limitations.
Since an insurance policy is a contract, provisions, terms, duties and liabilities vary. Also, each insurance company has its own contractual verbiage and limitations. As such, close attention must be paid to the provisions contained in each policy in order to ensure proper coverage.
A "claim" has been defined as a warning or threat of a possible future suit, the filing of a suit, or a client’s demand that the professional person cure defective professional services. In the event of a claim or a potential claim, the insured must immediately notify the insurance company. Careful adherence to the notice provisions contained in the policy must be specifically followed. Typically, the notice of a claim to an insurer should be in writing, providing the details of the malpractice. Notice of a claim or potential claim can also be made by phone or e-mail. However, it is strongly recommended that such notice be followed up with a hard copy.
Keep a copy of the notice in your files. Failure to abide by the notice provisions of the policy may provide the insurer the opportunity to deny the claim. Typically, claims are denied for failure to abide by the time limits of the notice provision if the insurer is prejudiced by the delay.
When a suit is filed against a professional or a professional corporation, the E&O policy provides a defense to that claim. This entails the retention of a lawyer to represent the insured’s interests in the litigation. Some E&O policies provide that an insured may be able to select counsel for defense of the claim. However, most policies do not include choice-of-counsel provisions. If the policy does not, an insured still may request to choose the counsel, subject to acceptance of the insurer. In any event, the legal fees and costs of defending the claim usually fall within, and therefore are applied to reduce, the limits of liability provided under the E&O policy.
Typically, a deductible must first be paid by the insured under the policy to cover the initial costs of defense. Legal fees and costs incurred in the defense of the claim typically are included in the deductible as well. The amount of the deductible depends on the type of policy and the premiums paid and can range from $500 to $10,000. As such, the amount of policy limits and the deductible must be carefully considered when purchasing an E&O policy. Obviously, the higher the amount of policy limits or the lower the deductible,the higher the premium.
Once the deductible is paid by the insured, the insured is not responsible to pay any further defense costs within the policy limit for the remainder of the litigation. However, defense costs are not without limit; they will be paid by the insurer only up to the policy limits. Should the defense costs exceed the policy limits, the insured is responsible for funding the defense.
It is axiomatic that an insurer has a duty to defend its insured for covered claims. If the insurer believes that the claim falls within a prior exclusion, an excluded act or some other policy exception, however, the insurer may elect to deny coverage forthright or defend the insured under a "reservation of rights." A "reservation of rights" means that the insurer will provide a defense; however, the insurer reserves the right to deny coverage of the claim as facts are developed that establish that a policy exclusion applies.
Under such circumstances as where a carrier denies the claim, or accepts the claim under a reservation of rights, the insurer may file a declaratory action to determine coverage under the policy. A reservation of rights may also be applied in a situation where a claim consists of both covered and uncovered claims. In such a situation, a carrier may have the duty to defend its insured, but may reserve the right to deny coverage to any adverse judgment that may be based on the uncovered claim.
As stated previously, if a claim is covered under the policy, the insurer has the duty to pay any settlement or verdict proceeds up to the policy limits. However, if the defense costs or the settlement or verdict exceed the policy limits, the insurer does not have a duty to pay any amount in excess of the policy limit. The insured must pay the remaining balance. Therefore, the professional or professional corporation should keep apprised of the amount of defense costs billed, the amount of claims filed under the policy, the status of continuing settlement negotiations as well as verdict potential.
E&O policies often contain a provision that requires the insured’s consent to settlement prior to the consummation of the settlement. Thus, a carrier cannot settle a case without the professional’s consent. However, these policies will also contain what is known as a "hammer clause." This clause provides that if the insured does not consent to a settlement recommended by the carrier, the limits of liability under the policy are reduced to that amount at which the carrier could have settled the case together with the defense fees incurred to that point. Thus, if the professional does not want to consent to the settlement, it is the professional who bears the economic risk of a verdict in excess of the proposed settlement.
An insurer may refuse to defend or indemnify an insured based on certain defenses. For example, prior excluded claims, specific excluded acts, lack of timely notice, or intentional acts are typical defenses for an insurer to refuse to defend its insured under the policy. Additionally, should the insurer discover that the insured made misrepresentations in the application for insurance, coverage may also be denied. Be that as it may, not all misrepresentations will trigger this policy defense. Rather, courts have generally held that the misrepresentation in the application must be intentional or material to the risk that is being insured.
Further, every policy of insurance has a "duty to cooperate" clause. This policy defense is triggered during the course of litigation if the insured fails to cooperate with the defense of the claim. If the insured fails to appear for depositions, tender documents or talk to the defense lawyers, etc., the insurer may refuse to provide indemnification should the case settle or go to verdict. It could also seek reimbursement of defense costs. Also, failing to cooperate could adversely affect the case. Therefore, it is in the insured’s best interests to fully aid defense counsel so that the insurer may not invoke this provision of the E&O policy.
It is vital for a professional or professional corporation to maintain adequate E&O insurance coverage. Strict attention must be paid to policy provisions concerning policy limits, excluded claims and claims procedures. Careful adherence to the policy conditions and requirements will mean quick and prompt resolution of claims without incurring unnecessary burden and expense.
