Product Fundamentals: Professional Indemnity Insurance
What is professional indemnity insurance?
Professional indemnity insurance is designed to protect businesses (including their employed principals and employees) from allegations made against them that they have failed to adequately provide “professional services”. As a result of that failure, parties relying on their “professional services” have, or are likely to, suffer loss.
Nature of contract
The policy is claims made: the allegations against the policyholder must first be made against it, and notified to insurers, during the period of insurance. For more information on claims made policies refer to our article here.
Indemnity provided by the policy
Insurers will indemnify the policyholder for:
- Defence costs and expenses - to assist the defence of the allegations; and;
- Damages - comprising of various forms of financial loss resultant of the liability of the liability professional and if awarded claimant’s costs and expenses.
In the event allegations of professional misconduct are made against the policyholder by its “professional body”, some policies may pay for representation costs at such inquiry and even compensatory penalties for breaches of particular statutory regulations.
Who requires the cover
In many professions, having professional indemnity insurance is compulsory. The professional must hold cover, up to a specified limit to be able to practice that profession. Some examples include:
Must comply with obligations to insure See our article on the Building Practitioners Act,
Must comply with the obligations under ASIC’s Regulatory Guide 126.
Must comply with AHPRA requirements.
Must comply with the obligations of the Pharmacy Board of Australia.
Must comply with the Institute’s requirements.
Must adhere to the Insurance Standards.
Otherwise the requirement to hold professional indemnity insurance is often found in the contracts professionals enter in to. Notwithstanding the obligations at law and under contract, where a person or company offers “professional services” it may have liability in connection with same. It is therefore have professional indemnity insurance to transfer any risk of that liability. Claims against professionals are frequent even if unfounded the cost of defending those claims can be significant.
Who is covered by the policy
The policy indemnifies the policyholder (being the entity named as the insured), its principals, partners, directors and employees. In the ordinary course, the policy will only cover the policyholder for its liability for claims that arise from any authorised representative, contractor or consultant (third party) it is responsible for or engages. Cover will not extend to indemnify the third party. Insurers may extend the benefit of the cover to such third party, but policyholders must be aware that risk exists in doing so. Our recommendation is, wherever possible, that third parties hold their own professional indemnity insurance.
Policy limit and excess
The policy limit is ordinarily for all claims and covered loss in respect of same that are notified during the policy period. The policy limit may be inclusive of legal costs that are incurred in the defence of a covered claim. Where the limit is stated as such, it means that the policy limit will be eroded by those legal costs and expenses. Where the policy limit is stated as “cost exclusive” it means that the insurer will pay in addition to the policy limit defence costs and expenses.
Sometimes the policy will include a reinstatement of the sum insured which will mean that where the policy limit is eroded by one claim (or a number of claims that have similar underlying facts or characteristics), the policy limit will reinstate for new claims (that have different underlying facts or characteristics to any other claim previously notified on the policy). Only one policy limit will apply to claims that have the same underlying facts.
As regards the excess where it is expressed as “costs inclusive” that means that defence costs will be payable by the policyholder until the excess is eroded. Where it is stated as “exclusive” it will only apply to damages paid under the policy. Like with the limit, where the same underlying facts exist in connection with a claim, only one excess will be payable. In a hard market, insurers may insist on the excess being payable for “each claimant”. This is of particular concern in respect of claims brought against financial services licensees where complainants allege miss-selling of their products.
Covered professional services
It is critical that the services performed by the policyholder are expressly defined by the policy. In most instances the “professional services” intended to be covered by the insurer will be expressly defined in the policy schedule. Sometimes however there will be a definition in the policy wording that sets out the services covered.
What is or is not a “professional service” is not always clear cut, particularly in businesses that provide a mixture of services. For the policy to operate properly in the event of a claim, it is critical that the professional services as defined in the policy are clearly set out and match the work performed by the professional. The ways to ensure this fundamental matter is properly dealt with is to focus on:
- Disclosures – make sure the insurer has an absolute understanding of the work being performed. Proposal forms assist the insurers understanding the nature of work the proposing policyholders do. But that is not generally adequate. The proposal form should be supported with supplementary information including capability statements, retainers and reports or advice templates. See our article on the importance of complete disclosure here.
- Avoid online transacting systems – it is critical that online platforms are avoided where a policyholder is engaged in diverse professional services. Online systems are built to work on generic professions.
- Check quotation terms – does the policy schedule or proposed policy definition of “professional services” match those being provided by the policyholder or as they have been set out in the disclosures?
- Check the exclusions that may be applied by “endorsements” or that are contained in the policy wording. Often these may purport to exclude some of the work undertaken by the professional that is sought to be covered.
The nature and value of the “professional services” performed by a proposer will influence insurer appetite for risk, coverage, excess and premium. Again, with increasing dependence on online transacting platforms we are experiencing more frequent instances of policies being issued that do not, at all, cover the work being performed.
What is not covered by the policy?
Some common exclusions include:
The policy will not cover any matter, fact, circumstance or claim that has been notified, or otherwise should have been notified in a prior policy period. Please refer to our article on claims made insurance here.
The policy will not cover any conduct giving rise to claims, where that conduct happened before the retroactive date. You must ensure that the retroactive date is at a time on or before the date in which you first started providing your services. Again here the claims made nature of the policy requires the policyholder to have high regard to the retroactive date. The retroactive date will be set in the schedule – if it is not there, the policy wording, in particular the endorsements, should be checked.
Cover is provided under a professional indemnity policy, by way of extension, to cover the policyholder for claims in connection with any fraud and or dishonesty of its employees, which may arise during the course of it providing its professional services.
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As stated above, contracts generally require professional indemnity to be held in connection with the services being performed under the agreement. The obligation is sought to continue for at least 7 years after the services under the agreement cease this obligation’s genesis being claims made nature of the policy and the Limitations Act.
The requirement by the principal for the professional to hold the cover is ultimately to transfer the promise to indemnify the principal as is often found in the agreement’s indemnity clause. The scope of the indemnity sought by the principal should, as far as practicably possible, match the indemnity conferred on the professional under its policy.
Often however, principals seek wider indemnities that extend the liability of the professional (see our article here). The professional may accept such liabilities contractually, but should be aware that in doing so, these liabilities that it assume exist only as a result of the undertakings it makes under such agreement. And where a liability exists solely by such undertaking, a professional indemnity policy will not cover it for loss in connection with that liability so assumed. On that basis it will be a commercial, uninsured risk where onerous liability for loss is assumed.
These exclusions limit the insurer’s liability to indemnify for a claim that arises from or is connection with bodily injury or property damage. In a hard market, insurers seek to apply such exclusions on construction, engineering and other property professionals. Having such exclusion applied significantly impacts the indemnity that ought to be available under a professional indemnity policy. It is critical that these exclusions are “written back” so that they do not apply if the claim arises from the covered professional services.
Again, in a hard market, insurers may apply these exclusion to construction and engineering professionals’ policies. The definition of “pollution” is critical as it may extend to a broad range of “pollutants” including asbestos. It is critical that these exclusions are “written back” so that they do not apply if the claim arises from the covered professional services.
“Professionals” provide advice, design or specification (professional services) in which third parties may rely. If those services are incorrect and the professional did not take reasonable care to ensure that the advice was correct, the professional may have a liability to the third party.
Some claims examples include:
- An architect might be sued by their client or subsequent owner of a building if the negligent design of a building resulted in weathertightness issues.
- An accountant might be sued because incorrect tax advice was given to a client resulting in an avoidable capital gains tax or late payment penalties being incurred; or shareholders of a company might sue if a negligent audit report was provided to the public.
- An engineer might be sued if he or she specified structural steel that was later found to be not sufficiently strong to support the building, which caused economic rather than physical loss or damage to a later owner.
- A financial services licensee may be pursued by an investor into one of its funds who alleges misrepresentations in a disclosure document. An investment was made based on those representations. But for the representations the investor would not have invested.
- Some professional indemnity policies will also extend to cover a professional business from statutory claims brought against them pursuant to the Australian Consumer Law. Such claims often arise from the provision of advice in circumstances where it is alleged that a professional has engaged in some form of misleading conduct. For example, a real estate agent may make a statement in the course of marketing a property for sale. The agent may later be sued by a person claiming to have been misled about a particular characteristic or value of the property which caused the person to enter into a particular transaction or take a particular course of action that they would not otherwise have taken. Such allegations are easy to make but are much more difficult and costly to defend.
For personalised advice regarding Professional Indemnity Insurance and to obtain a quote, please contact us via the form below.