Canadian Underwriter

Does Your Life Jacket Fit?

June 16, 2014   by Michael Densham

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Definition of a liability headache: a well-meaning marketing consultant sends off materials to a bank’s high-risk credit applicants that were supposed to go to its low-risk applicants. This mistake resulted in a flood of useless applications for the bank and
$500,000 in defence and settlement costs for the consultant.

Without proper insurance coverage, mistakes such as this can be financially crippling for companies. When facing management and professional liability claims, small- and mid-sized private Canadian companies are often expecting too much from their general liability (GL) insurance policy—and are potentially exposing themselves to costly uninsured losses.

According to a Chubb Insurance Company of Canada survey, Canadian private companies are keenly aware of their directors and officers (D&O) and errors and omissions (E&O) exposures and are concerned about the financial risks they pose. However, about one-half of the 302 decision makers surveyed believe that their GL insurance will cover their management and professional liability risks. But GL policies typically provide only limited protection—if any—against D&O and E&O liability losses.

Recognizing the Risks

Asked to identify the risk they feared could most harm their organizations financially, 18% of respondents cited E&O litigation. That response rate is even more significant when considering that just over half (55%) of all respondents provided professional services for a fee. Private company executives need to consider if their company can bear the financial burden of a costly E&O liability lawsuit.

Another 14% of respondents believed that D&O litigation is their biggest risk—a fairly low percentage of respondents, given that these lawsuits can be a threat to the viability of a business. This is especially true for small- to medium-sized companies.

In one D&O liability case, for example, management of a company that sold a capital asset currently faces a huge misrepresentation claim from the buyer. The plaintiff claims the asset needs $8.6 million of repairs to make it operational, and that the defendants knew about this shortcoming but failed to disclose that information before the sale. The defendants have already incurred defence costs of $689,000 in the dispute.

A Common Threat

E&O and D&O losses and liability lawsuits are not uncommon. Most respondents (84%) reported their companies faced management or professional liability risks, or sustained D&O or E&O liability losses, between 2010 and 2012. More than half (52%) reported a management liability-related event. Many respondents also noted their companies were contemplating activities that would increase those exposures. For example, 31% expected to engage in major mergers or acquisitions, and 18% anticipated selling a portion of their businesses within a year—activities that increase management’s exposure to misrepresentation claims.

In one D&O misrepresentation lawsuit, a company incurred $585,000 of defence and settlement costs to resolve a $10 million claim by an investor who alleged that management personally wooed him with promises of several new product launches within a year. The company did not introduce the products, and the value of the plaintiff ’s investment fell.

Among survey respondents who did not purchase D&O or E&O insurance, 58% expected their GL policies would cover management liability claims, while 45% expected similar coverage of professional liability losses.

Those respondents had good reason to be wary. The primary purpose of a GL policy is to protect management and employees from claims arising out of property damage or bodily injury. Certain GL policies may include some D&O coverage, but they may lack the breadth and depth of protection that a stand-alone D&O policy can offer. GL policies typically exclude coverage for claims alleging:

  • management wrongdoing leading to financial loss;
  • financial damages resulting from professional services.

Those exclusions also mean a GL policy will not cover any legal costs incurred while defending against those D&O and E&O claims.

Calculating Costs

The average E&O loss among survey respondents was $106,000. But companies with as few as 100 employees reported losses exceeding $250,000, and 57% of the respondents disclosed E&Orelated events that cost their organizations between $25,000 and $250,000. Half of the E&O losses were reported by companies with 100 or fewer employees; those losses ranged from $2,500 to $75,000.

Respondents at companies that sustained D&O liability losses reported average total costs related to a loss, including judgments, settlements and legal fees, of $71,000. But for many, the costs were higher. Companies with 50 to 99 employees reported losses of $105,000 on average, while those for companies with 25 to 100 employees—which accounted for half of the reported D&O losses—ranged up to $250,000.

The largest reported E&O and D&O losses were $500,000. Both losses were sustained by companies with 100 to 249 employees.

It’s clear that companies of all sizes are exposed to management and professional liability risks. The potential cost to defend and settle these claims needs to be weighed against a company’s cash flow. Will a management or professional liability lawsuit severely impact the livelihoods of employees and owners? If the answer is yes, then private company executives should consult with their trusted advisers to build a risk management program to help mitigate the company’s D&O and E&O liability risk, including appropriate insurance products.

Copyright 2014 Rogers Publishing Ltd. This article first appeared in the May 2014 edition of Canadian Insurance Top Broker magazine

This story was originally published by Canadian Insurance Top Broker.