This article will provide an overview of the nature of professional liability policy coverage triggers (in comparison to general liability triggers), professional liability policy deductibles and settlement concerns, the forms such professional liability policies take and the rationale behind the existence of various professional liability forms. In order to highlight the importance of a well-negotiated contract, the article will then discuss how professional liability coverage interacts with the terms in professional services agreements.
In general, design professional liability policies (or errors & omissions/E&O) provide coverage for third-party claims against the insured design professional arising out of negligent acts, errors or omissions in the performance of professional services. Design professional coverage is not first party coverage. The design professional cannot make a claim against its own policy for harm caused to itself. For example, a design professional cannot recover for its own fees incurred as a result of correcting errors or omissions in its drawings. Likewise, the design professional cannot expect that his professional liability policy will provide coverage in the event he brings a fee collection action against the Owner. The policy is purely defensive. In order for a claim to be covered, the claim must be brought by a third party, e.g., the Owner of a project, another design professional, a contractor or a member of the public.
In contrast, general liability policies are intended to provide coverage for bodily injury or property damage which occurs on the premises owned by the design professional or where the design professional is working (except for those injuries covered by workers compensation, professional liability policies or other insurance policies). General liability policies typically exclude coverage for bodily injury and property damage which arise out of the performance of professional services, and for economic losses. That is not to say that all claims which are brought against a design professional are not covered. If, for example, a client visits the design professional's firm and trips on a rug and injures himself, that claim would be covered under the GL policy.
What are the coverage trigger's for design professional liability policies vs. general liability policies and how do they differ?
General liability policies provide coverage on an occurrence basis. When a claim is brought under a general liability policy, the insurer looks to when the act which gave rise to the claim took place. If the act which gave rise to a claim occurred within a policy year when coverage was in place, the claim will be covered regardless of when the claim is actually brought. For example, assume in 1996 the glass in a high rise tower blows out due to poor construction and injures a pedestrian. The pedestrian does not bring a claim against the contractor until 1999. Let's assume the contractor has carried a general liability policy every year since it went into business in 1995. Because the act that caused the harm, the blowing out of the glass, occurred in 1996, the claim would be covered by the policy in place in 1996 even though the claim occurred in 1999. The insurer looks to when the act giving rise to the claim occurred, not when the claim itself was made. Of course, the determination of when an act or occurrence gave rise to a claim can be a complex issue and is highly dependent on the nature of the case and the language of the policy.
In contrast, professional liability policies provide coverage on a claims made basis. The determination of coverage under a claims-made policy, can be more complicated. An insurer will first look to when the claim was brought and determine if there is an active policy in place at the time the claim was first made. In order for a claim to be covered under a claims-made and reported policy (the most typical type of claims-made policy), the claim must be made within the term of the policy and reported within the term of the policy or within sixty days thereafter (within the automatic extended period). Second, the insurer will determine when the act giving rise to the claim occurred to determine if the act occurred within the policy's retroactive date. The retroactive date is the date from which insurers have agreed to provide coverage for acts which could lead to claims. Often this date coincides with the date that the design professional first purchased coverage through a particular insurer.
It is imperative that design professionals report claims on a timely basis so as not to jeopardize coverage. Assume that the design professional carried coverage on an annual basis from January 1, 1995 to January 1, 2001 with a full prior acts retroactive date. Assume that in August 1997, glass from a high rise tower blew out and injured a pedestrian below. In November 1999, the pedestrian wrote a letter to the design professional threatening suit and demanding $1,000,000. The design professional thought the contractor was primarily responsible, and therefore, did not report the claim until April 2000 when he was actually sued. Since the retroactive date extended back to 1995, the act giving rise to the claim (the 1997 accident), was within the retroactive date. (While the insurer could certainly interpret the "act" which gave rise to the claim to be the preparation of the design, most insurers would focus on the actual "act," the harm, which most proximately caused the claim, in this instance, the falling of the glass.) However, since the design professional knew about the claim in November 1999 but reported it after that year's policy expired on January 2000 and after the sixty day automatic extended period which ended on March 1, 2000, the insurer could deny coverage for the claim in the January 1, 1999 - January 1, 2000 policy term.
The insurer may also deny coverage for the claim under the January 1, 2000 - January 1, 2001 policy term. Design professional policies explicitly exclude coverage for claims which are known by the design professional at the time of renewal. Thus, if a director, officer or principal of the design professional firm had knowledge of an actual or alleged breach of professional duty or circumstance likely to give rise to a claim and the firm fails to disclose it in its firm's application for insurance, the insurer may have a basis to deny coverage.
Failing to maintain professional liability coverage on a continuous basis can cause gaps in coverage which can have serious repercussions. For example, assume that glass blows out of a high rise and injures a pedestrian in 1996. The pedestrian brings a claim in 1999 and the design professional reports the claim in 1999. Assume that the design professional had purchased coverage in 1990 and continuously renewed it until 1995 when he allows coverage to lapse. In 1997, the design professional renews his coverage. In the above claim scenario, since the act giving rise to the claim occurred in 1996, which was before the 1997 retroactive date, the claim would not be covered.
Deductibles and Settlement Considerations
The insured design professional is usually responsible for a deductible before the insurer will pay any defense or indemnity costs.
Another type of deductible arrangement is a first dollar defense deductible. This means that the design professional's deductible is only applicable for indemnity purposes, i.e., for settlement or judgment costs. The insurer will pay for all defense costs from dollar one.
Professional liability coverage typically requires that claims expenses (defense costs, expert costs, etc.) be "within the limits" as opposed to "in addition to" policy limits. This means that policy limits are eroded by claims expenses. As a result, the expenditure of claims expenses reduces the limits and, thus, the amount of money available to pay judgments or settlements.
Most professional liability policies contain a consent clause with respect to settlement of claim. A consideration of insurers during settlement is the use of the consent-to-settlement provisions and "hammer clauses" in the policy. Because the insureds are professionals with reputations at stake, professional liability policies require that the insurer receive the insured's consent prior to settling any claims. As typically written, consent-to-settlement provisions allow the insured to veto any proposed settlement to which the insurer and a claimant might have tentatively agreed.
There are two important elements contained in the consent-to-settlement provision. First, the insurer is required to seek the insured's consent prior to settling any claim. However, if the insured withholds consent to a settlement, the insurer may exercise the "hammer clause". If the ultimate resolution of the claim exceeds that settlement amount, the insurer is liable only for the settlement amount upon which it initially agreed. In addition, the insured will be liable for those additional defense costs and expenses accrued from the point it refused to settle forward. For example, say a settlement demand is made for $50,000 which the insurer thinks is reasonable. The insured design professional refuses to consider the settlement and wishes to try the case. The insurer can exercise the "hammer clause" and take the position that it will pay $50,000 but any defense or indemnity costs in excess of that amount are not covered by the policy.
Practice v. Project Policies
There are two primary types of design professional policies. The first is a practice policy. These policies provide coverage for all of the professional liability claims which arise in a given annual term. The limits of these policies, which are on average $1,000,000, can be eroded by claims arising from any of the work the design professional performs in that year and often in prior years.
The second primary type of design professional policy is the project policy, which typically covers all design professionals on a given project. In the absence of a project policy, an owner must rely on each design professional on the project to provide evidence that it has specified amount of limits in place under the design professional's annual practice policy and that its policy terms provide adequate coverage. This arrangement may not always provide adequate comfort or protection to the Owner. The cumulative policy limits may be inadequate, particularly if depleted by claims on other projects.
Coverage may lapse before the expiration of any applicable statutes of limitation or repose. There are plenty of opportunities for gaps in coverage.
Insurers developed the project policy in response to the need to eliminate such gaps and to make the insuring of projects more manageable. Unlike practice policies which cover each design professional firm separately, the project policy covers all of the design professionals including all of their subconsultants on the project under one policy. The project policy covers the term of the project plus provides a discovery period which usually matches or at least approaches the statute of repose and provides adequate limits dedicated to that one project. The Owner is assured that limits are in place and that all parties are covered and that the terms of the policy are consistent and negotiated as fairly as possible. There is no administrative hassle of verifying coverage on an annual basis. Since Owners are historically the most likely claimants on construction projects, Owners are particularly concerned that there will be sufficient limits under design professional policies to cover their claims.