Errors and omissions insurance background
Financial institution errors and omissions (E&O) coverage is a relatively modern policy. Legal claims asserting professional negligence only came to prominence in the 1970s; prior to that time legal actions against financial managers were extremely rare.
While the general public may be most familiar with doctors and lawyers malpractice insurance, the concept of professional liability has expanded to include other professions – including financial institution management. “E&O” is the common way of referring to the financial services industry’s version of professional liability insurance.
What is the purpose of errors & omissions liability insurance?
An E&O policy is the insurance that covers your financial institution in the event that a customer or stakeholder holds you responsible for a service you provided, or failed to provide, that did not have the expected or promised results.
Physicians buy malpractice insurance, while lawyers and accountants buy professional liability insurance – regardless of the underlying line of business, this type of insurance protects against errors that others perceive caused them damage.
Most E&O policies cover judgments, settlements and defense costs. Even if the allegations are found to be groundless, thousands of dollars may be needed to defend the lawsuit. They can bankrupt a smaller company or individual and have a lasting effect on the bottom line of larger companies.
E&O insurance also helps manage legal costs in responding to formal regulatory or administrative proceedings – in connection with a financial institution’s activities.
In short, E&O coverage provides protection for you in the event that an error or omission on your part has caused a financial loss for your client.
What are the risks covered? What are the risks that are not covered?
Most E&O insurance policies are structured to meet the specific needs of the business. E&O insurance provides protection against third-party liabilities arising out of the provision of its professional services. Such liabilities arise from:
- Breach of agreed investment parameters
- Breach of management contracts
- Perceived underperformance
- Lack of due diligence prior to investments
- Alleged dishonest acts of employees
- Incorrectly executed trades
- Failure of internal risk control
What is covered?
Up to the policy limit, these are covered:
- Errors and omissions made by the insured professionals
- Defense costs
What is not covered?
- Intentional wrongdoing or harm—dishonest, fraudulent, criminal, or malicious acts or omissions
- Illegal acts—willful violations of any state or regulation committed by an Insured
- Attributable to such gaining any personal profit to which they were not legally entitled
- ERISA Violations
- Claims brought or maintained by any Insured under the policy
- Actual or alleged bodily injury, sickness, disease, death, or damage to or destruction of any tangible property- Actual or alleged employment practices violations
- Liabilities assumed under contract
Insurance Company Professional Liability
For insurance companies, E&O exposures come from both clients and regulators. E&O litigation is often brought by policyholders alleging bad faith, with accusations of alleged misconduct in handling policyholder claims.
Claims can also arise from alleged mis-selling of insurance contracts based on the suitability of the product to particular clients.
Bad Faith Claim
A bad faith claim is litigation brought by a policyholder against an insurance company, alleging bad faith and seeking punitive damages for perceived misconduct in handling claims.
Hurricane Katrina, for example, sparked a great deal of litigation, which stiffly punished insurers for acting. Specifically, policyholders sued insurers for not meeting a 30-day deadline to adjust claims after satisfactory proof of loss. Defense costs were also accumulated by courts divided over whether to apply anti-concurrent-causation clauses, which block insurance coverage when losses are caused simultaneously by a covered peril (wind) and an uncovered peril (flooding), and how the flood exclusion is specifically applied.
Coverage restrictions have emerged from poor loss histories, including
- product class exclusions
- product class sub-limits
- increased retention levels and/or coinsurance
Bankers professional liability
Claims against banks mostly arise from unhappy customers or regulators. Banks face many types of claims from mis-selling and wrongful foreclosures to unfair loan terms and discrimination.
Claims Example: A small community bank works with a securities firm to provide broker services to some of its customers through a dual-employee agreement, and the bank relies on the securities firm to supervise the broker’s activities. The broker embezzles from several customer accounts and mails false statements to hide the missing funds. Once the fraudulent activity is discovered, the affected customers sue the bank for negligent supervision.
Investment advisors E&O
Investment advisors are typically exposed to claims brought by clients and investigations brought by their regulators. The credit crisis of 2008 resulted in many investment vehicles not performing as expected, which led to many investors bringing allegations of being mis-sold products that they didn’t fully understand. Other typical claims come from trade errors, wrongfully valuing illiquid products and breach of investment mandate.
E&O policy forms can be tailored to meet the specific needs of each insured, including for the newly emerging risks arising from technology startups including non-bank lenders, FinTech firms and robo advisors.
Common risk factors that affect pricing:
- Class of business, types of services rendered
- Historical performance
- Financial data (assets under management, revenue, gross written premium)
- Investment strategy (portfolio concentration, leverage, liquidity)
- Counterparty risk
- Type of clients (high net worth, qualified investors)
- Due diligence policies and procedures
- Compliance practices
The policy limit is an “annual aggregate,” meaning that there is only one single limit of liability for all claims against all insureds during one policy year. Unless regulated differently by law in the respective country, all defense expenses and other costs are part of this single limit.
“How much” E&O insurance to purchase is an individual business decision, which should be influenced by the following factors:
- risk tolerance
- professional services sold (and to whom)
- strength of balance sheet
- claims history
- amongst other things
Using these factors, in addition to peer benchmarking, and/or broker supported analytics (used to predict frequency and severity of losses) can help determine the appropriate limits a financial institution should purchase.
In addition, clients of financial institutions often have minimum insurance requirements that can determine ultimately what limit is purchased. Pricing and retentions will vary dependent on the risk profile of the business.
Limits can also be purchased separately or combined with all lines of coverage such as D&O, fiduciary, cyber, fidelity, and EPLI. Benefits of purchasing combined limits (blend) include cost-effectiveness and efficiency. Benefits of purchasing separate limits is having a dedicated limit for E&O claims that will not be eroded by other lines of business, and the ability to choose from different primary carriers.
Primary insurers continue to be disciplined with their underwriting for bankers and insurance company professional liability, as prior policy year losses and increased claim frequency on earlier policies continue to develop.
For accounts with higher risk profiles, the insurance market is much more challenging—underwriters ask for both higher retentions and increased premiums. Appetite for investment advisors/asset managers remains strong as this sub-sector of the industry has historically been more profitable for the insurance industry that supports them.
Financial regulators require that institutions demonstrate policies and procedures and adequate supervision. This same information is invaluable to the insurance markets. Submitting documentation of personnel experience verification, independent third-party reports, as well as specific due diligence and training examples can help the underwriters better understand an institution’s risk profile.
Department of Labor – Proposed Fiduciary Rule
In April of 2016, the U.S. Department of Labor expanded the definition of “investment advice fiduciary” under ERISA. Under the rule change, any individual, firm, financial institution or affiliate (including relatives) receiving compensation, either directly or through an indirect fee arrangement, for advice that is directed to a particular plan sponsor or participant, or an IRA owner considering a retirement investment decision, is a fiduciary.
The rule is currently delayed under the new administration. At the time of this writing, implementation of the rule change is still unclear. Ultimately, any expansion of the definition of “investment advice” will likely result in more claims against a broader set of advisers.
In recent years the SEC has taken an active interest in the asset management industry bringing the highest number of investigations and enforcement actions on record. Traditional E&O policies for asset managers contain varying levels of investigation coverage. The future remains to be seen as to how the changes at the SEC will affect the number of future actions that will be brought.
Cost of insurance claims
Largely due to the continued low interest rate environment, many life insurers have been re-pricing their life insurance contracts to adjust to these new market conditions. The re-pricing has resulted in numerous class actions alleging abuse of contract conditions and mis-selling.
Guest blogger James Jackson is Senior Vice President of Willis Towers Watson’s FINEX Financial Services Industry Practice, based in New York. James joined the company in 2007 and has extensive knowledge of and experience placing the Management and Professional Liability (Directors & Officers, Errors & Omissions, Employment Practices, Fiduciary and Fidelity) lines of coverage for both commercial and financial institution clients.
Guest blogger Clare McCarrick is a Placement Specialist in Willis Towers Watson’s FINEX Financial Services Industry Practice. Located in New York, Clare provides global risk solutions to financial institutions and commercial companies on the Management and Professional Liability (Directors & Officers, Errors & Omissions, Fiduciary, Employment Practices and Fidelity) lines of coverage.