What E&O Limits Do I Need?

Author: VU Faculty

In determining the limits an independent insurance agency should carry in an E&O/excess liability policy, what factors should be considered? Is it a matter of how much the agency can afford, how large an error or omission could be made, the size of the accounts at risk, etc.?

“In determining the size of an umbrella that an independent insurance agency should carry over their own E&O/professional liability policy, what factors should be considered? Is it a matter of how much the agency can afford or how large an error or omission could be made? What about the size of large umbrellas (manuscript policy) that our clients carry? Could you please provide some guidelines?”

The question, “What liability limits do I need?” is one that probably cannot be answered. It’s the same question your insureds routinely ask. For some general guidelines, here is a VU article on this: “What Liability Limits Do I Need?” The following are additional VU faculty comments on your specific question.

The size and complexity of your accounts is one factor. The value of your agency is another. Exposure to regional catastrophic loss should be considered as well. Do you have agents with limited skills handling complex accounts? Can your agents explain every single coverage on their checklist to a plaintiff’s attorney, without notes, and exhibit a high degree of business acumen?

What degree of business acumen is found within your firm? Does your staff know what they don’t know? Do your procedure audits find persistent problems? What type of catastrophic E&O loss exposures are within your book of business? Assume a worst case scenario. Err on the side of conservatism.

There is no way to determine a “satisfactory” umbrella limit. A company of substantial size cannot buy enough insurance to protect its assets. The necessary limits are those that make the insured entity “comfortable.” Verdict and judgment history in the jurisdiction and limits purchased by peers and competitors might be helpful.

A hard question to answer given so many variables. Here a few questions to consider:

At what point could the liability be so large as to wipe out all the real financial value of the agency?

How big of an E&O claim could you have? Do you get involved with large, complex businesses with interlocking arrangements with other businesses?

At what point would you say, to heck with it, I’ll just start over?

While it’s rare, we’ve seen E&O verdicts in excess of $20 million. It’s like answering your customer’s question as to how much to carry. The only safe answer is, “More.”

Since it is extremely difficult to determine the nature of the error or omission and the amount of possible damages, an agent take into consideration the same rules imposed on prospective insureds: Buy all you can afford because the exposure can be as high as the sky.

As an agency, your exposure is the largest policy you fail to recommend.

The first item to determine is the size of a possible loss. For a personal lines agency or even one that writes only small commercial accounts, that might be $5,000,000. For agencies that do large commercial accounts, it might be $100,000,000 or more.

Second, what degree of certainty do you want that the limit will be adequate? Actuaries regard a 95% confidence level as high degree of certainty for loss reserves, although that means, it seems to me, that the reserve will be exceeded, on average, once in 20 years.

In what states do you do business? How does those states view insurance broker/agent E&O? New York, for example, generally does not accept the “ya shoulda told me” claims by policyholders. On the other hand, New Jersey courts can be very generous to an insured whose agent did not recommend adequate insurance.

Finally, how much can you afford/what do you want to spend?

“Don’t risk a lot for a little.”

One school of thought is a small agency/broker has the same risk as a large agency/broker. I don’t agree. If I’m arranging insurance for someone with a $300 million property schedule, the potential effect of an error is $300 million. So on the basis that larger brokers deal with larger clients, larger brokers have a larger E&O exposure.

I guess there’s potential for unlimited exposure on third party liability but I’d say that *in general* that increases with size of client and therefore *in general* that increases with size of broker. Of course, the *in general* bit is important. I know a couple of brokers with total premium income of around $8,000,000 where $6,000,000 of that comes from one single commercial client, and that would skew the E&O exposure.

Of course a small broker can go out of business faster and use bankruptcy as a risk management tool faster. A big broker may have better tools to protect against an E&O, but a big broker is big so it is harder to control everyone. A big broker can’t get insurance and has to take a large retention. A small broker can get a small retention, but may only purchase small limits.

Food for thought:

http://specialtyinsurance.typepad.com/specialty_insurance_blog/2007/09/insurance-agent.html

http://www.insurancejournal.com/magazines/southcentral/2007/08/06/coverstory/82808.htm

http://specialtyinsurance.typepad.com/specialty_insurance_blog/2007/09/the-agents-eo-m.html

http://specialtyinsurance.typepad.com/specialty_insurance_blog/2007/07/california-fire.html

http://www.insurancejournal.com/magazines/west/2004/02/23/legalbeat/37129.htm

http://www.insurancenewsnet.com/article.asp?a=top_pc&q=0&id=93295

http://www.alpinerisk.com/ClaimsExamples.html

Just look at this list of coverage extensions:

http://www.darwinpro.com/products/agente_o.html

I think the question that can be answered is how small of an umbrella should we carry. It is true for insurance agencies and their clients. Limits should always be higher than the value of the largest possible property damage exposure. Tenants in an apartment building should carry limits of at least the value of the building, everyone else’s contents and all of the loss of use expenses. Agencies should carry at least the value of the value of the largest property they insure. Limits beyond that are preferred. There are few multiple million dollar losses but they do exist. If you injured someone who made $100,000 (or more) to the extent they could no longer work and they were age 40, the loss of income from 40 to 66 is at least $2.6 million. That does not include any other costs.

Another element of this is the self-characterization of the agency’s services. From one end of the scale where the agent is merely a place to buy insurance, to the other where they hold themselves out to “handle all of your risk management problems,” there’s a continuum that will help guide the decision.

Your limit needs to be greater than or equal to the biggest claim you will have to pay. Of course, if defense is within limits, you’ll need more. Considering that Agent’s E&O is a specialized coverage, many umbrella carriers may not be willing to attach over $1 or $2 million primary, or any primary for that matter.

I have a certificate from a major west coast broker and the limit is $25,000,000 with a $1,000,000 deductible. The entire limit is with the same carrier. Now they might have an umbrella and just don’t list it. A large broker could have $100 million or even more (I don’t know the market capacity for this coverage) but for an agency with under $10,000,000 in premium revenue, $5 million would probably be adequate based solely on the type and complexity of programs placed.

For any agent, documentation is paramount. Back in the early 90’s, I placed some business with a large (BI Top 100) local independent agent. My account rep went through every policy page by page and I initialed each page to confirm that I understood the form and what it did.

Just as with small businesses, the limit selected will be influenced by how much it costs. Your state Big “I” association may have some information on the largest claims against their membership. Find a balance between the limits you might need and the limits that you can afford.

The question I would first ask is not how much the agency can afford…that won’t be an issue if there is a loss but rather if the (specific) type of claim your client could face could be covered under umbrella policies you are considering.

The first thing to consider is whether the agency is a corporation. A potential problem often ignored is in relation to corporations looking for coverage is whether their corporate shield is at risk if failure to procure adequate coverage results in the entities inability to cover a claim.

If the umbrella policies you are looking at will not and cannot cover the exposure without generating a premium that will be commercially impractical, then the limits of coverage should be based on what would be considered reasonable in that area.

If, on the other hand, coverage is available at an acceptable cost, then in addition to securing reasonable limits your client would also want to add the limits necessary to ensure survival of the entity (assuming it is concerned with maintaining the integrity of the entity).

I wonder about the protection offered by a corporate structure. In New York, at least, individuals are sub-licensees and would therefore seem open to suit as an individuals in addition to the corporate entity. Whenever we send out RFPs for insurance quotations we always ask for certificates for E&O coverage. Based on what we get, I’d guess that most agents carry limits well below their maximum possible exposure.

Buy as much as you can afford because when a big loss happens you can count in two things:

1) You will never see it coming.

2) You will wish you could have seen it coming.

We carry a $5,000,000 limit and probably need to increase that amount. $5,000,000 doesn’t go very far these days. We are loyal to the companies that are loyal to us. I know the companies we represent that will stand beside me and I know the companies we represent that will not stand beside me.

I really think the need for the limits can vary by size. However, when placing workers’ comp, remember that coverage A is statutory and in the case of a para or a quad or other catastrophic injury, you can see damages of $30M or greater.

When I see the verdicts coming in lately, if I were an agent writing any commercial lines coverage, I’d want pretty significant limits.

Note: Several of the comments above come from risk management practitioners on the RiskLikst email group. This Yahoo! group consists of insurance and risk management professionals from around the world and is an excellent source of information about technical, real world insurance and risk management issues.

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