By LISA DOHERTY, co-founder of Business Risk Partners, a provider of professional and management liability solutions
Tough economic times bring out the entrepreneurial spirit in small business owners as they look for ways to maintain revenue in a down market. As errors-and-omissions (E&O) insurance underwriters looking at hundreds of different segments of business, we often see expansion into areas that creates exposures for firms that they may not even be aware of. Or unintended new exposures can occur during downsizing, employing independent contractors or crime perpetrated by disgruntled employees.
1. Branching into Affiliated Services
When a company offers new services, a lack of coverage might result under their traditional E&O policy, or could cause an increase in rates as underwriters evaluate these new exposures. Firms should contemplate the potential liability of expansion in evaluating the opportunity.
For example, a mortgage broker starts serving as a loan modification consultant. A p.r. firm engages in media buying. An insurance agent begins offering loss-control services. Businesses often take on work in affiliated areas tied to an industry but not their actual profession to generate revenues and seize on emerging opportunities in tough times. From being so familiar with their industry, they surmise they know enough about a new service area to make the leap.
Yet often in these cases, the firm and its employees lack sufficient education or training to establish and follow best practices--the perfect set up for an E&O claim with allegations of negligence and errors from providing services resulting in financial damage to clients.
Worse yet, when faced with a lawsuit, current E&O policies may not cover the cost of defense and damages if the service wasn't included on the original policy or added later under the description of services performed.
Many businesses learn this lesson the hard way. Take the real estate broker. Facing declining sales, she started offering mortgage broker services after a bank enticed her with the promise of a commission for every borrower she sent its way. The deal was simple. All she needed to do was get potential borrowers to fill out the paperwork and send it in. The bank would take it from there. Years later, though, when one of her clients defaulted on a loan, the broker was sued for poor advice and for not sufficiently explaining to the borrower that the loan was structured with low initial payments followed by a large balloon payment due at the five-year mark.
The realtor thought she was qualified to secure financing for clients--especially since the bank made it so easy--simply from her familiarity with mortgage brokers and contracts. What she hadn't realized was the complexity of documentation and the need to present options during the selection of a mortgage. Once she helped the buyer secure financing, she created a new set of professional obligations for herself.
The lesson? When adding a service, always confirm with your insurance broker that it's covered. If it's not, be sure to specifically add it to your E&O policy. Additionally, it's wise to include coverage for referral services, so that if a client you've directed to another firm has a problem with that company down the road, exposure from the referral will be covered under your E&O policy.
2. Expanding Geography
Businesses can also become vulnerable to E&O claims from expanding their service territory. For example, in search of added revenues, real estate appraisers have increasingly ventured beyond their home turf to less familiar regions. Lawsuits have arisen out of ill-informed evaluations made by appraisers with inadequate knowledge of the new neighborhood or area.
The situation becomes even more complicated when expansion crosses state lines in classes of business subject to state regulations. For example, in recent years, many firms and solo practitioners--including lending institutions, law firms, credit counselors and debt management advisors--have expanded into the lucrative area of collections. These firms and professionals must possess the knowledge and expertise needed to deal with added layers of regulations unique to a particular locality.
While an E&O policy typically provides coverage nationwide, it's still imperative when expanding geographically that firms and employees possess adequate training and education--that they "know their stuff."--to lessen exposure and risk.
3. Skill Gaps Left By Downsizing
An e-commerce Web site developer promises to have a new site ready by November 15. They go through a layoff and reduce the staff by 30 percent. With too few employees left to complete the project, they miss the deadline, and the client misses that critical holiday selling season.
Reducing staff may appear to improve the bottom line, but not when the outcome means insufficient resources for servicing clients. Have you promised a level of service that you can't possibly deliver? Are you keeping too few employees with the skill sets needed to adequately complete the job? Are you unable to finish a project on time?
Untimely delivery, misrepresentation, misstatement, system failure and even negligent oversell are all grounds for an E&O claim.
When reducing staff, companies often let go of higher-paid workers, the more experienced employees. When swapping out a $60,000 person for a $20,000 one, the quality of work may suffer. An unseasoned employee is far less likely to pick up on the nuances of the assignment and likely lacks what it takes to run a project.
And with training budgets slashed, people are being asked to pick up responsibilities without adequate training. It's amazing the number of firms that fail to recognize the skill-set gaps created during downsizing until it becomes painfully apparent that no one in the company knows how to do certain things.
Businesses should also consider the impact of reduced staff on maintaining best practice policies. For example, in an insurance agency, the person who placed the policy typically hands it off to a "second set of eyes"--someone who will do a policy check-in to make certain everything was done correctly.
During layoffs, firms should make certain their bases are covered, such that particular skill sets are not lost, or that there is a clear segregation of duties for tasks that require two individuals. They should have a plan in place to maintain high-quality service.
4. Employing Independent Contractors
To reduce overhead commitments, many businesses are hiring independent contractors. Although you might not be that familiar with the contractors or be able to exercise as much control over them as you would like, once you subcontract with them to complete work on your behalf, you assume liability and exposure for their actions.
Not all E&O policies pick up independent contractors. Know what your policy includes and make sure that the work of any independent contractor you hire is covered under your existing E&O policy.
Mitigate risk by putting controls on independent contractors, from reviewing company policies and best practice procedures with them to holding frequent meetings. In addition, a well-defined contract, laying the respective obligations of parties, assists in the event of a dispute. To further protect the firm, the contract could also contain a requirement that the independent contractor maintain his or her own coverage and name the client as an additional insured.
5. Theft of Third-Party Assets Can Trigger E&O Policy
Employee theft or crime--typically covered by fidelity insurance--is more prevalent than people think and all the more so in tough economic times. E&O policies can also be triggered by these events under a professional service error or omission if someone alleges the firm demonstrated negligence by improperly supervising employees.
For example, in the case of financial management, the company could be accused of failing to set up or maintain certain mitigating procedures for fraud and embezzlement, such as segregating duties so that the person collecting the checks is not the same person depositing them. Monthly reconciliations by another person also helps reduce this exposure.
Finally, the firm should have adequate fidelity coverage to respond in the event employee theft occurs. Proper fidelity coverage would indemnify the client, reducing the potential for a negligent supervision E&O claim.
If you have questions concerning how best to head off any potential E&O claims, it is always best to call your broker or carrier. Many offer their insureds pre-claim assistance through a toll-free hotline.
December 1, 2009
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