How Much E&O Insurance Do I Need?
Remember the following mantra when you begin the process of purchasing an insurance policy: Every claim against you and your company, and all of the legal fees that go with those claims, will have to be paid. The key is whether it is the insurance company which pays the claim, or whether you pay out of your own pocket.
With that in mind, let’s start with the basics. Errors and Omissions (E&O) insurance is another name for professional liability insurance. E&O is the insurance you purchase to protect yourself and your business from financial liability in the event an error or omission occurs which causes damage to a third party. According to The Insurance Journal, “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.” Remember, every claim against you and your company, and all of the legal fees that go with those claims, will have to be paid in full. The key is whether it is the insurance company which pays the claim, or whether you pay out of your own pocket. The most important question, therefore, becomes: “How much E&O insurance do I need?”
Step 1) Determine if you need E&O insurance.
If you are a real estate professional, from an appraiser who performs one appraisal a month to a broker who handles hundreds of sales a year, you NEED E&O insurance. Even if you have never had a claim against you, and even if you keep meticulous records, you still have potential to make a mistake. Further (and maybe more importantly!), even if you did not make a mistake, a person or entity for whom you performed a service can still ALLEGE you made a mistake. The long story short is that, if you provide a service to a client for a fee (and sometimes even if you just offer advice), you have the potential of being sued.
Step 2) Purchase an E&O policy PRIOR to working for a client.
You must purchase E&O insurance PRIOR to performing any professional service. Insurance does NOT provide coverage for events that took place prior to the inception date of the policy. Please note that many Lenders/Financial Institutions have minimum limit requirements of $500,000/$1,000,000 for real estate professionals who do work for them. In addition, several states require real estate professionals to carry E&O insurance. Most importantly, however, is that your potential clients will feel more at ease working with you when they know you carry E&O insurance, as it tells them that if you make a mistake, you have the means to reimburse them for it.
Step 3) Assess your financial situation.
Examine your current finances and financial statements. Count the value of all of the assets you own and the income you earn. You will want to understand what you stand to lose in dollars as well as assets if you were to be sued by one of your clients. Remember, every claim against you and your company, and all of the legal fees that go with those claims, will have to be paid in full. The key is whether it is the insurance company which pays the claim, or whether you pay out of your own pocket.
Step 4) Think about the services you perform and how much loss you could incur.
Think about how much loss you could incur from a single client if a mistake is made by you or your employees. Then think about the number of transactions that you do per year. Ideally, you would want to have a per claim limit that is at or above the most you could possibly lose in any given transaction, and an aggregate limit which totals the maximum amount you could lose per transaction multiplied by the number of transactions which you perform per year. This will determine the amount of E&O insurance you may need.
For example, the most commonly purchased limit in our program is $1,000,000/$1,000,000. $1,000,000/ $1,000,000 means that the most the insurance company will pay per claim against you is one million dollars, and the most they will ever pay out in a policy term is one million dollars. So, if you have three claims in a given year, each for $300,000, your aggregate loss would be $900,000. All three claims would be paid in full. However, if you have four claims for $300,000, totaling $1,200,000, the first three claims would be paid in full, and the final claim against you would exhaust your aggregate limit of $1,000,000. Therefore you would have to pay the remaining $200,000 out of your own pocket. Remember, every claim against you and your company, and all of the legal fees that go with those claims, will have to be paid in full. The key is whether it is the insurance company which pays the claim, or whether you pay out of your own pocket.
Finally, remember that many times, an agent or appraiser will perform the same action for many years, not knowing that the action was wrong. What this means is that you may have YEARS worth of errors building up. If one client sues you for that error, others may realize that the error has been made. This can lead to numerous claims against your policy in a single year, many resulting from actions you or your firm performed three or even five years ago. Make sure to factor in this additional risk and exposure when purchasing your insurance.
Step 5) Purchase a policy.
Ultimately, you have to choose for yourself how much insurance you need. No one else can make that decision for you. Make sure that prior to making your decision to purchase a policy that you balance the cost of the policy, the coverage the policy offers, the limits of the policy, and how much risk you are willing to take on by yourself. A little bit of thought now can save you years of headaches and aggravation later.