If you handle construction cases, ask yourself this question: Would you be willing to read a brief contract, if doing so might result in a benefit worth anywhere from $100,000 to well over $1,000,000 for your architect, engineer, or other design professional client?
Yes? Then read your client’s professional liability (errors and omissions) insurance policy.
You don’t need to become an insurance agent to understand the basics of professional liability coverage and apply them to your practice (although I did). If you learn the ABCs of E & O, however, you can maximize benefits to your clients and help them avoid jeopardizing coverage.
Below, I discuss the application of a typical professional liability policy to a few situations that are likely to arise in the current "hot" market for design professionals’ services. Bear in mind, though, that there is no substitute for reading your own client’s policy, as terms differ.
The current strong economy has fueled a very competitive market for professional liability insurance. Prices are low and terms are favorable. Your design professional client may be tempted to change carriers. This is a serious step, and price should not be the only consideration. Your client should review the prospective insurer’s policy, reputation, and longevity in the market with her professional liability insurance agent.
When your client changes carriers, she risks being caught in a coverage "gap" if claims or potential claims have gone unreported to the original carrier. Your knowledge of the policy reporting requirements can save your client from disaster.
The potential for a gap is inherent in the fact that professional liability insurance is written on a "claims-made" or "claims-made and reported" basis. This bit of insurance jargon means that a claim will not be covered by the policy unless it is made against the insured and reported to the carrier during the policy period (or any extended reporting period). When a claim is made, it is reported to the design professional’s current carrier, and the current policy terms will apply.
How could your client fall into the gap? Suppose she has a policy with Ace Insurance, effective January 1 through December 31, 2000. In August 2000, she receives a letter from her client, King Development, threatening suit if she does not pay $50,000 for alleged errors and omissions in her professional services. You assist your client in drafting her response. She decides it is an idle threat and does not report it to Ace.
On January 1, 2001, she switches carriers and purchases a new annual policy from Deuce Insurance. In June 2001, King Development files suit against your client for professional negligence. She promptly reports the claim to Deuce Insurance.
Deuce may deny the claim, or at best assume defense under a reservation of rights. Deuce can argue that the claim was made prior to inception of its policy, at the time your client received the demand letter from King Development. Deuce’s policy defines a claim as "a demand for money or services." Deuce can also cite its policy exclusion for "claims of which the insured was aware prior to policy inception."
The loss of coverage in the foregoing example could have been avoided. If you understood the reporting requirements of the policy, you would have identified the letter from King as a claim, and advised your client to report it to the carrier immediately.
Be aware that many carriers offer special incentives for early reporting. For instance, some carriers offer free legal services for problems that are reported before they ripen into a demand for money or services. Your knowledge of these policy features can save your client thousands of dollars in legal fees, and may also result in early resolution of difficult situations.
Getting it Right From the Start for New Firms
The current construction boom has led to an unprecedented demand for design professionals’ services. This has encouraged many to start their own firms. When your client is starting a new firm, advise him to consult with an insurance agent who specializes in professional liability insurance coverage for design professionals. Unanticipated liability awaits those who delay purchasing coverage.
The hidden liability arises from the fact that new professional liability policies usually have a retroactive date. A claim will not be covered unless the alleged negligent act, error, or omission from which it arises occurred after the retroactive date of the professional liability policy. Typically, the retroactive date of a new professional liability policy is the effective date.
Here’s the trap for the unwary new firm. Suppose your client starts his own practice on January 1, 2000. During the first year, work pours in, and he struggles to meet all of the demands made of his new, wildly successful firm. On January 1, 2001, he feels financially secure enough to purchase professional liability insurance. The retroactive date is the same as the inception date – January 1, 2001.
On January 15, your client is served with a complaint for professional negligence arising from a project completed in 2000. He promptly reports the claim to the professional liability insurance company. Unfortunately, the carrier denies the claim. The negligent acts, errors, and omissions alleged in the complaint all occurred before January 1, 2001 – the retroactive date of the policy.
Reducing overhead is a real problem for new firms, but delaying the purchase of professional liability insurance is a poor solution. Work done prior to policy inception typically will not be covered by a professional liability insurance policy.
Your client may be pleasantly surprised by the pricing and terms available for new firms. Many carriers offer a "small firm" program with excellent pricing, favorable terms, and guaranteed annual premium for two or three years. Many agents also offer premium financing or payment plans to ease the financial burden of premium payment.
The present demand for design professionals’ services gives them – and you – a real advantage in negotiating fair contract terms with project owners. Your knowledge of professional liability coverage will enable you to identify uninsurable provisions and negotiate terms that provide optimal coverage.
It is not my purpose to catalogue all insurability problems. There are several useful publications on this topic, and your client’s professional liability insurance agent can be an excellent resource. If you understand the risk that professional liability insurance is meant to cover, however, you are well on your way to spotting many insurability issues.
In general, professional liability insurance covers damages caused by an insured design professional’s negligent acts, errors, and omissions in the performance of professional services. When design professionals contractually assume liability for more than their own negligent acts, those additional liabilities are uninsured. Indeed, professional liability policies typically contain a specific exclusion for these "liabilities assumed by contract."
For example, some contracts require design professionals to assume liability not just for their own negligence, but for their failure to achieve perfection. Your client may be asked to sign a contract that requires her to exercise the "highest" or "best" standard of care. This far exceeds the negligence standard, under which your client is obliged only to perform with the care and skill ordinarily exercised by members of the same profession, practicing under similar circumstances. The additional liability imposed by the "perfection" standard is uninsurable.
Your client may also be asked to sign contracts with uninsurable indemnification provisions. Consider the following:
The Architect shall defend and indemnify the Owner from any damages caused in whole or in part by any act, error, or omission of the Architect, except those caused by the sole negligence of the Owner.
This provision is uninsurable. Recall that the policy will only pay for damages caused by your client. Accordingly, a promise to "defend" the owner is not covered, because it obligates your client to retain and pay for the owner’s attorney, even if your client ultimately bears no liability.
For the same reason, your client should not assume liability for damages he causes "in whole or in part…except those caused by the sole negligence of the Owner." Here, even if your client causes 1% of the damages, and the owner 99%, your client promises to pay 100%. Professional liability insurance will only cover the 1% caused by your client. Another problem: The sample indemnity incorporates the uninsurable "perfection" standard of care.
It calls for your client to indemnify for "any act" which causes damages, rather than negligent acts. As discussed above, perfection is neither possible nor insurable.
As you assist your design professional clients in negotiating insurable agreements, bear in mind that insurability benefits both parties to the contract by maximizing coverage for the design professional’s services. If insurable terms cannot be negotiated, your client must carefully weigh the additional risk in deciding whether to proceed with the project.
Armed with a working knowledge of professional liability insurance, you can help your clients obtain the maximum benefit from their policies, and avoid jeopardizing coverage.
1 For example, suppose your client has a policy with an effective date of January 1, 2000, with an aggregate limit of $500,000. On January 1, 2001, she renews with the same carrier, and increases her aggregate limit to $1,000,000. If a claim is first made and reported during 2001, the $1,000,000 limit will apply – even if the claim arises out of services performed during 2000.
2 An application form for professional liability insurance typically requires the applicant to list any known claims or potential claims. The design professional in this example obviously ignored this question.
3 Some policies go further and exclude "claims of which the insured should have been aware." That is, they apply a subjective standard to the issue of awareness. Obviously, this is less desirable as it allows more ground for denial of claims on this basis.
4 Typically, the retroactive date will be the effective date of the design professional’s first professional liability insurance policy, so long as the design professional has continuously maintained coverage since that date. Some policies state that they are "full prior acts" – that means that there is no retroactive date limitation on coverage.
5 See, e.g., DPIC’s Contract Guide: A Risk Management Handbook for Architectural, Engineering, and Environmental Professionals. Monterey, CA: DPIC Companies, Inc., 1999.
6 For the same reason, guarantees and warranties pose insurability problems.
Karen J. Dilibert is employed by the Illinois State Bar Association Mutual Insurance Company as Director of Marketing. She has extensive experience in the field of professional liability insurance. Ms. Dilibert obtained her Undergraduate Degree from the University of Chicago (A.B. 1984, Politics, Economics, Rhetoric, and Law, Phi Beta Kappa). She obtained her Law Degree from the University of Chicago (1990).