15.3 Professional Liability and Errors & Omissions

Professional Liability and Errors & Omissions

Professional liability (also called errors & omissions, or E&O, and malpractice in medical contexts) covers economic loss arising from a professional's negligent act, error, or omission in rendering or failing to render professional services. The defining exam distinction: a CGL covers bodily injury and property damage, while professional liability covers purely financial/economic harm from faulty advice or service. A CPA who files a client's return wrong, an architect whose design specs are flawed, or an insurance agent who fails to bind requested coverage all face E&O exposure, not CGL exposure.

Claims-Made and the Retroactive Date

Nearly all professional liability is written on a claims-made basis, not occurrence. Two dates control coverage:

• Retroactive date - the earliest date a covered wrongful act may have occurred. Acts before this date are excluded.
• Policy period - the claim must be first made and reported during this window (or an extended reporting period).

For a claim to be covered, the wrongful act must occur on or after the retroactive date, AND the claim must be first made during the policy period. Both conditions must be satisfied.

The Coverage-Trigger Grid (heavily tested)

Extended Reporting Periods (Tail Coverage)

When a claims-made policy is canceled or non-renewed, an Extended Reporting Period (ERP), or tail, lets the insured report claims after expiration for acts that occurred during the policy term. A basic (mini) tail is automatic and short (often 60 days for reporting, with a longer 'midi' window for acts already discovered). A supplemental (full) tail is purchased, can be unlimited in duration, and must be requested within a set window (commonly 30 to 60 days after expiration).

Intentional Acts and Defense Costs

Professional liability covers negligence, not intentional or fraudulent acts, criminal conduct, or bodily injury (those route to CGL). A defining feature is defense within limits (also called 'eroding' or 'wasting' limits): defense costs are subtracted from the policy limit rather than paid in addition. This is the opposite of a CGL, where defense is usually outside the limit.

Worked Example: Eroding Limits

A design firm carries a $1,000,000 E&O claims-made policy with defense inside limits. A covered claim incurs $250,000 in defense costs and settles for $900,000.

• Total demand on the policy: 250,000 + 900,000 = $1,150,000
• Policy limit: $1,000,000
• Insurer pays: $1,000,000 (defense + indemnity combined)
• Insured pays out of pocket: $1,150,000 - $1,000,000 = $150,000

Because defense erodes the limit, the firm is underinsured by $150,000 even though the settlement alone was below the limit.

Per-Claim vs. Aggregate Limits

Professional liability policies carry both a per-claim limit and an annual aggregate. A '$1M/$3M' E&O policy pays up to $1,000,000 for any single claim and $3,000,000 for all claims in the policy year. Once the aggregate is exhausted, no further coverage applies even if the per-claim limit was never reached on an individual matter. Exam questions test whether multiple claims have eroded the aggregate.

Consent-to-Settle ('Hammer') Clause

Many professional policies require the insured's consent to settle because a settlement can damage a professional's reputation. To prevent an insured from unreasonably refusing, the policy adds a hammer clause: if the insured refuses a settlement the insurer recommends, the insurer's liability is capped at the amount it could have settled for plus defense to that date. The insured then pays any excess. This is a classic distractor on the national exam.

Prior Acts and Nose Coverage

When a professional switches carriers, the new claims-made policy can grant full prior acts (no retroactive date) or set a retro date equal to the new policy's inception, leaving a gap. Nose coverage (a prior-acts provision) on the new policy mirrors the function of tail coverage on the old one. Buying either nose or tail at a carrier change prevents an uncovered window for acts already committed but not yet claimed.

Defense-Within-Limits and the Consent-to-Settle (Hammer) Clause

Professional liability/E&O policies carry two structural features that distinguish them from the CGL and that the exam targets. First, most are written with defense costs inside the limit (eroding/"wasting" limits), so every dollar spent defending the claim reduces the money available to pay the claimant — the opposite of the CGL's costs-in-addition structure. An insured with a $1,000,000 limit and $300,000 in defense costs has only $700,000 left to settle.

Second, the consent-to-settle ("hammer") clause requires the insured's consent to settle, because a settlement can damage a professional's reputation; if the insured refuses a settlement the insurer recommends, the hammer clause caps the insurer's exposure at the proposed settlement amount plus defense costs to that date, shifting further loss to the insured.

Nearly all E&O is claims-made with a retroactive date, covering only wrongful acts after that date and claims first made (and reported) during the policy or an Extended Reporting Period. Prior-acts coverage and tail options manage the transition between insurers.