A broad guide for businesses in what to look for in the purchase of Professional Indemnity insurance
What is professional indemnity insurance?
Professional indemnity insurance (“PI”) is designed to cover a business for errors made when providing advice and services to clients. The exact parameters of the cover will vary with different insurers and wordings, and this document is not intended to circumvent the importance of reading, reviewing and understanding your individual policy wording.
PI policies will, in general, cover a business for errors or omissions made whilst advising or servicing clients. It will usually provide cover for not just the damage caused by the mistake but also the legal costs and expenses of investigating and, if justified, defending the business’ advice and conduct. Payment of the legal costs of defending an allegation of negligence or similar is often the part of the cover most appreciated by an insured business.
All business’ should discuss their own cover with your insurance advisor or broker however PI can also include extensions providing insurance for reconstituting a client’s documents if lost or destroyed (“loss of documents cover”), loss of money due to dishonesty (“fidelity cover”) or the costs of appearing in official investigations by tribunals, ombudsman bodies or even royal commissions (“Inquiries costs cover”).
What is meant by “Claims Made and Notified” basis of cover
The vast majority of PI insurance is written on a “claims made and notified” basis. This means that the policy in force when a claim is first made against the business and notified to the insurer on risk is the policy that will respond to the insurance. This differs from “losses occurring” policies where the date of the incident will determine the policy which responds to the claim.
As an example if inappropriate advice was provided to a client in 2006 but that client only complained about the advice in 2007 the policy in force in 2007 would normally cover the claim.
Conversely the 2008 PI insurers will likely include terms that will exclude any claims that the business already has received – even if they have not yet been notified to the 2007 insurer.
This policy structure makes it essential that businesses immediately notify their PI insurers when a claim is made against them.
Circumstances that may give rise to a claim
In addition to any claim made against them every business has a right under statute law to notify to their insurers any facts that they think may in future give rise to a claim (usually termed as a “circumstance” by PI insurers). Again, as a result of this right, PI insurers will, at the beginning of a policy, exclude any circumstances that the business is aware of irrespective of whether the previous PI insurer has been notified.
If you don’t notify claims or circumstances when you first become aware of them a later insurer may not cover them under their policy.
What is a circumstance?
This is a question that has been before a number of courts but is still difficult to define. Broadly a circumstance can be viewed as a set of facts that if an average business had been in possession of would have recognised that a claim may later arise against them.
These could include such issues as a business knowing it has given incorrect advice (even if the client does not yet know) or even if a business knows that a client is of the belief that the advice was incorrect (even if the business disagrees).
Importantly it is still a circumstance even if the business correctly considers that the advice was correct. If a claim is made against them at a later date it does not matter if the claim is misconceived and unjustified. A claim or circumstance should be considered irrespective of the business’ view of the merits. This is because the PI policy will usually provide cover for the legal costs to defend any unjustified allegation against the business and so will be called on even if a claim has no merits.
What is meant by Retroactive Coverage and Retroactive Date?
A Professional Indemnity policy may provide coverage for negligent acts committed prior to the policy inception date provided they are not known to the insured and the insurer at the time of policy commencement and are notified as soon as possible within the policy period.
The retroactive date is the date in the past beyond which acts committed by the insured will not be indemnified by the insurer.
For example: An engineer provides structural design services for a building complex in January 2013. In December 2013, halfway through its construction it becomes apparent that that it is not structurally sound, requires demolition and re design.
The engineer purchases professional indemnity insurance in October 2014 with a Retroactive Date of 1 January 2014. He approaches his insurer in November 2014 having received a letter from the developer holding him liable for losses arising from the negligent design work.
The insurer declines his claim for legal defence costs on the basis that the retroactive date is after the date on which the design error occurred and became apparent.
Check your polices have a retro-active date set at as “unlimited” or the date the business was established to avoid not being insured in these circumstances.
What is “Continuous cover” and why is it important this cover be considered before changing my PI insurer?
Claims Made policies generally exclude Claims arising from facts and circumstances known to the insured before the start of the policy period. An inadvertent and innocent failure to disclose a known fact or circumstance that gives rise to a Claim could result in an uninsured loss.
Continuous Cover clauses address this situation by extending cover under the policy to a Claim arising out of a fact or circumstance which could have been notified under a previous professional indemnity insurance policy but the insured failed to do so.
For a Continuous Cover clause to apply, usually the insured must have been insured under a professional indemnity insurance policy issued by the insurer at the time they first became aware of the fact or circumstance that gives rise to the Claim. The Claim must have been covered under the previous policy and the insured must have been continuously covered, without interruption, by a professional indemnity insurance policy with the insurer until the time when they notify the Claim to the insurer.
Note: This cover will usually only be provided where there has not been any fraudulent nondisclosure or fraudulent misrepresentation by the insured.
Remember if you change insurer, this benefit is lost if provided by your current insurer and it is important thorough enquiry of all staff is made to ensure all possible known circumstances are reported to the outgoing insurer before cover expires and coverage with the new insurer is incepted.
As a matter of disclosure the new insurer should also be aware of the circumstance.
Why are “Civil Liability” PI polices generally considered better than “negligent act, negligent error or negligent omission wordings”?
When professional indemnity liability wordings were first introduced into the insurance market, they were largely based on the concept of negligence. PI policies were devised to cover the costs incurred by the insured in compensating a third party for breaching his or her duty of care.
A PI policy that provides coverage on this basis will generally only cover losses where it could be shown that:
- the insured owed a duty of care to the claimant,
- they breached that duty and
- their breach caused loss to the claimant.
The standard of care expected of professionals is typically that of a competent person who meets the standard of practice accepted by professional peers in their relevant discipline.
Very often, claims are made against professionals under the tort of negligence and also under contract for negligent breach of professional duty. But what if a claim includes other legal grounds?
For example, what if the claim was that something said during negotiations persuaded the claimant to enter into the contract and this statement turned out to be wrong?
The claim could be based on misrepresentation or misleading and deceptive conduct. Or there may be allegations of breaches of various statutory obligations. Some contractual terms are typically implied into contracts by both the common law and by statutes. An example of such an implied term is that goods or services supplied must be fit for the purpose for which they were supplied. If liability to the claimant did not arise out of negligence but on other legal grounds, an insured could be left without cover and could be at risk of personal financial liability.
A PI policy that covers only negligence therefore provides a significantly narrower coverage than other types of wordings available in the market.
It is becoming more common to see “civil liability” wordings in the PI insurance market. Such policies typically cover the insured for claims arising from their civil liability provided such liability is incurred in the course of performing their professional services. This is broader than one based on negligence or breach of professional duty, in that negligence is not the only basis of coverage and the insured does not have to show that the claim arose out of a breach of professional duty in order to fall within the scope of its insurance policy.
Civil liability, as the name suggests, is liability that arises out of civil law, as opposed to criminal law. Criminal liability or penalties that could be imposed by statutes, for instance, would not fall within this coverage.
Civil liability can be said broadly to fall into four categories:
- tort law such as the law of negligence, nuisance or defamation;
- contract law:
- statutory obligations such as consumer protection legislation; and
- equitable breaches which are based on principles of fairness and justice – including breaches of fiduciary duties or breaches of trust.
As such, avoid totally policies that have in their Insuring clauses “Breach of professional duty by Act, Error or Omission caused by Negligence”. It will not pick up any claims relating to Statutes such as Consumer Protection legislation, or Health & Safety Acts (unless extended accordingly)
A Civil liability policy does not set boundaries (other than the exclusions) as to the nature of the wrongdoing. It may encompass more than just negligent acts errors or omissions and include breach of duty of trust, conflicts of interest, breach of statute law and defamation. These may not necessarily arise from negligence and therefore may not be covered under a negligence policy.
Look for language in the policy that states language along the lines of “We agree to pay to or on behalf of the insured all loss resulting from any claim for any civil liability in relation to the conduct of the policyholder’s professional business.”
Why is it important for my insurer to understand my business activities?
Typically the insurer will limit cover to the professional service or professional business specified in the policy schedule or as defined by the actual policy document if it is an industry specific PI policy.
Ensure your adviser and insurer has a solid understanding of all activities conducted by the firm.
For example, rather than having the policy schedule reflect professional services as “accountant” a more thorough disclosure of activities may be:
- accounts preparation and bookkeeping
- audit work for non publicly and publicly listed companies
- business and management consulting
- advice and training on accounting software
- superannuation fund accounts preparation and bookkeeping
- tax advice
- forensic accounting
- company directorship and/or secretarial positions “
This is an example only, the business description should always be tailored for your specific business needs.
It is important that the Professional Services description in a professional indemnity insurance policy matches the activities performed by the insured because generally loss is covered in connection with the Professional Services only.
If any of the professional services conducted by your business are not presented to the insurer and reflected in the policy document or schedule the insurer may have grounds to deny cover.
What is the difference between a “Costs Inclusive” and a “Costs Exclusive” excess?
Costs Inclusive – The excess applies to the aggregate of damages, defence costs and penalties (if insured).
Costs Exclusive – The cost of defence is paid in full by Insurers regardless of any excess provision.
Cost exclusive excess is advantageous as your insurer will only ask you to pay the excess when a claim is settled or a court awards damages.
Why is it important to check my Territorial & Jurisdictional limits of cover?
Territorial Limits clauses restrict cover to Claims resulting from the conduct by the insured of Professional Services in certain countries. A narrow Territorial Limits clause will restrict cover to operations in certain named countries. A broader Territorial Limits clause may cover the conduct of Professional Services worldwide.
It is typical for a Territorial Limits clause to exclude Professional Services of the insured performed in the United States of America, provided to persons in the United States of America or subject to the law of the United States of America.
Jurisdictional Limits refers to the countries where the policy will respond to Claims being made against the insured.
If the Jurisdictional Limits are restricted to certain named countries then the policy only responds to Claims in those countries. If it is ‘worldwide excluding United States of America’ then the policy responds to Claims anywhere in the world except in the United States of America.
A typical ‘worldwide excluding United States of America’ Jurisdictional Limits clause, would provide cover for Claims made against the insured anywhere in the world, except for Claims brought in a court in the United States of America, or that arise from a judgment or order of a court in the United States of America.
If you’re providing professional services in or for other territories, please ensure the policy is extended to cover claims brought in these territories and their court system.
What is a “severability and non-imputation” clause and why is it important for multi-partnered or multi-employee businesses?
A Severability and Non-Imputation clause applies where there is more than one insured person or more than one insured legal entity under a professional indemnity insurance policy.
This clause protects an innocent party insured under the policy where there has been a failure of another insured to:
- comply with their duty of disclosure under the Insurance Contracts Act 1984 (Cth); or
- comply with any obligation, term or condition of the policy.
This clause will also protect an innocent insured where another insured undertakes any dishonest, fraudulent, criminal or malicious act so long as the innocent party had no prior knowledge of these acts.
The effect of the clause is that cover will still be available to the innocent insured despite the failure of the other insured party.
This is important for larger firms so the entire policy is not voided by one individual under the PI insurance contract.
PI Purchase Checklist
- Notify PI insurer of all claims/circumstances before current coverage expires
- Notify your insurance adviser/broker of all claims/circumstances as they happen
- Check the Retroactive date of cover is sated as unlimited or the date the business commenced operating.
- Check your continuous cover clause and if changing insurers be weary of its loss especially for larger firms where known circumstances may be inadvertently not reported to the outgoing insurer
- Purchase broad “civil liability” insuring clauses not “negligent act, negligent error or negligent omissions” policy construction
- Ensure all the Business Activities and Professional Services are conveyed to your insurer and presented as covered in the policy schedule or policy itself.
- Check how the excess applies and whether it is applied as soon as defence costs are incurred or only when a judgement or settlement is made
- Check Territorial & Jurisdictional Limits if providing advice and services to others outside of Australia
- Check the policy treats each insured party or person to the contract individually and that where another insured undertakes any dishonest, fraudulent, criminal or malicious acts the innocent party is still insured if he or she had no prior knowledge of these acts.
- Lastly, the easiest thing to compare in insurance is the cost of cover rather than the breadth of cover. Cheaper is not always better, more expensive is not always better. Only a competent adviser can assist you with a full policy comparison suited to your individual needs and risk profile. Please utilise an adviser who can demonstrate and articulate the differences in coverage available in language you understand and can guide your decision making processes when selecting insurers and their policy terms.
Everest Risk Group (ERG) is a full service General Insurance consultancy firm with a focus on the design, placement and management of:
- Asset and Liability Protection
- Professional Indemnity covers
- Directors’ and Officers’ Liability Risks
- Financial Institutions
- Industry & Affinity Group Placements
- Business Continuity & Succession Planning
It is our strategy to work with you to understand your business model and associated exposures to develop a tailored Insurance & Risk Management Program.
Our aim is to become an extended part of our client’s business, leading to long term stable relationships.
Please feel free to contact us at email@example.com or via Ph: 02 9226 2180