What it means
General liability insurance covers physical harm and property damage, such as a customer slipping in a shop. It does not usually cover financial loss caused by bad advice or a missed step in a professional service.
E&O insurance fills that gap by responding when a client says that your work cost them money. Typical claims include a missed deadline, an incorrect calculation, failure to deliver what was promised or advice that turned out to be wrong.
Even if the claim has no merit, defending it can be expensive, so the cover for legal fees is often as valuable as the cover for damages. Many policies are written on a claims-made basis, meaning that the claim must be made while the policy is in force.
Pricing depends on the profession, the size of the firm, its claims history and the limit chosen. Policies include a retention or deductible, the amount the business pays first, and a limit, the most the insurer will pay.
Exclusions are important, because things such as fraud, criminal acts and known problems are usually not covered. Some clients and professional bodies require E&O cover as a condition of doing business or holding a licence.
Having it can therefore help win contracts. It also gives owners peace of mind that a single error will not threaten the whole business.
Good risk management still matters. Clear contracts, written scopes of work, quality checks and prompt record keeping reduce both the chance of a claim and the cost of defending it.
Insurers often ask about these controls when quoting and may offer better terms to firms with strong procedures.
In practice
Real-world examples.
Example
An independent bookkeeper misses a tax filing deadline for a client, who is fined $5,000. The client demands compensation. The bookkeeper's E&O insurer covers the claim after the retention. She also reviews her checklist to avoid a repeat.
Example
A software firm delivers a payroll system with a calculation bug that overpays staff at a customer's business. The customer sues for $400,000. The insurer appoints lawyers and pays for the defence. The firm fixes the bug at its own expense while the claim is handled.
Example
An insurance broker fails to arrange cover that a client requested, and the client suffers an uninsured loss. The client brings a claim for the shortfall. The broker's own E&O policy responds, subject to its limit. The broker's premium rises at the next renewal.
Formula
Calculation
Insurer payment = Lower of (Covered loss - Retention) and Policy limit
Worked example: A consulting firm has E&O cover with a $1,000,000 limit and a $10,000 retention. A client claims $180,000 in covered losses caused by a modelling error.
Covered loss less retention = $180,000 - $10,000 = $170,000
Policy limit = $1,000,000
Insurer payment = $170,000, as it is lower than the limit
The firm pays the first $10,000 itself, and the insurer pays the remaining $170,000, plus legal costs under the terms of the policy.Case study
Seen in the real world.
Meridian Advisory is an illustrative, fictional firm of five consultants that helped small manufacturers prepare financial forecasts. A client used one of its forecasts to take on new debt, and when sales fell short, the client blamed the forecast.
The client claimed $250,000 in losses. Meridian believed the forecast was reasonable, but the cost of defending the claim could have exceeded $60,000 even if it won. The policy also covered the cost of an expert adviser who reviewed the original model.
In this illustrative story, Meridian notified its insurer immediately, as the policy required. The insurer appointed lawyers, and the matter settled for a modest amount, leaving the firm to pay only its $5,000 retention. The partners later added disclaimers on forecast assumptions to their engagement letters.
Watch out
Common mistakes.
- Assuming general liability insurance covers professional mistakes, when it normally excludes financial loss from advice or services.
- Reporting a claim late, when claims-made policies often require notice during the policy period.
- Choosing the lowest limit to save premium, when one claim can easily exceed a small limit once legal costs are included.
Questions
People also ask.
What does claims-made mean?
It means that the policy covers claims first made while it is active, so cancelling it may leave earlier work unprotected unless extended reporting cover is bought. This extended reporting cover is often called a tail.
Who needs E&O insurance?
Professionals and firms giving advice or services for a fee, such as accountants, consultants, designers, agents and technology providers, often need it. Some clients and licensing bodies make it a condition of the work.
Does E&O cover intentional wrongdoing?
No, deliberate fraud or dishonesty is generally excluded.
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