The Broad Brush "Errors & Omissions" (E&O) insurance, which protects against any litigation threat that extends beyond the value of the customer contract itself, is as essential to a professional-services provider as flood insurance to a Mississippi Delta homeowner. Even more so, in fact.
The homeowner only stands to lose a home and its contents, while a small solutions provider who gives bad advice or oversees a runaway project may be liable for many times the asset value of his or her company.
John Wurzler, whose firm, Wurzler Underwriting Managers, offers a "media technology and professional liability" policy geared to IT solutions providers, says the problem with off-the-shelf E&O insurance is that it excludes practically every type of liability exposure commonly encountered in consulting/systems integration engagements.
"More and more [integrators] are buying specialty blanket coverage of their entire IT exposure," says Wurzler, whose clients include Hewlett-Packard, IBM, MVP.com and Symantec.
A good high-tech E&O policy, says Summits Wagner, at minimum should negotiate around the standard contractual liability exclusion that effectively indemnifies the insurance carrier against all liabilities. Wagner suggests your E&O policy should have language that excludes coverage only to the extent that the liability "would not have arisen absent the contract."
In other words, if your client claims that your custom application failed and caused damage to its business, the insurance carrier will no doubt argue that the performance of the software is covered in the original sales contract and will use the existence of that contract as the basis for denying coverage. But if your E&O policy specifies coverage of all claims that would have been made in the absence of a contract, then the above-mentioned application failure would be fully covered.
Ted Doolittle, the manager of Internet E&O at Carpenter Moore Insurance Services, says a standard E&O policy also is likely to contain liability exclusions for unauthorized system access, "advertising injury" (injuries to other parties stemming from incorrect or misleading information on your Web site), fraudulent acts by your employees and electrical failures.
"What you want to do wherever possible is amend this preamble language to make it more favorable to you," Doolittle advises. "For example, with electrical power failures, you could narrow the exclusion from charges arising out of to charges for. … Thats a significant difference in your level of liability exposure."
You may be able to buy E&O coverage for specific contracts, but blanket coverage is a lot less expensive. Plus, insurers hate issuing policies for individual engagements. One reason, Doolittle explains, is the threat of ancillary suits from customers on similar projects.
Prices for blanket E&O coverage vary widely—anywhere from $5,000 to upward of $50,000 a year for $1 million in coverage. How much coverage should you take? Experts say thats a function of your balance sheet, your previous job performance, your level of confidence in tackling difficult projects and your faith in your people. But a $50 million integrator probably shouldnt hang a shingle without at least $5 million in E&O insurance.
Another staple for solution providers is so-called "crime" insurance, which shields you from liabil- ity stemming from the illegal actions of your employees. An example, says Wurzler, would be a member of the integrators project team who surreptitiously builds a backdoor into the customers system and uses it to steal credit-card data. If that theft seriously damages the customer, the integrators liability could be enormous.
Wurzler says a stand-alone crime policy typically is priced at about $10,000 for $1 million in coverage. But if bundled into an E&O policy, he adds, you can get that crime protection for roughly $2,500.
Completion bonds, similar to those that underlie all big-budget motion pictures, are finding their way into the high-tech industry. That type of insurance usually is demanded by the customer—often government agencies—and paid for by the vendor. Its growing popularity is a function of the complexity of e-business projects; the inexperience and incompetence of some solutions providers; and, now, the threat of insolvency that dogs an increasing number of e-services firms.
And finally, some ASPs and ISPs are buying protection against suits stemming from their failure to meet their contractual service level agreements (SLA). Although all contracts specify remedies—monetary penalties, damages, right to terminate clauses, etc.—Wurzler notes that the contract SLA provisions are sometimes "too weak," and vendors seek out added peace of mind.
"This is not a cookie-cutter business," says Wurzler. "Every warranty program we create for a company is different."
D&O, Not "Doh!" Professional liability insurance, however, protects only the firm against losses due to poor performance or malfeasance. It does nothing to insulate the officers and directors of a company from the threat of a lawsuit; a threat that is all too real these days, as angry shareholders react to the continuing meltdown in their high-tech portfolios.
"Where professional liability coverage slips off, director and officers [D&O] coverage picks up," notes Madelyn Flannagan, VP of research and education at the Independent Insurance Agents of America, a national trade association. She recommends that every public and privately held company that has a board of directors invest in D&O coverage.
D&O insurance covers directors and officers of a company that is accused of financial shenanigans, such as fraudulent earnings reports or illegal employment practices, including age and race discrimination. The insurer will pay the legal defense costs and most—if not all—of the settlement or jury award if the suit eventually goes to trial.
D&O insurance offers another major benefit. It helps firms, especially startups, attract good people to serve on their boards, says Robert John Wekselblatt, an insurance broker in San Francisco. Many experienced business people, especially those with substantial personal assets, wont join a board unless the company indemnifies them against claims.
While the most frequent claims covered by D&O insurance relate to employment practices, shareholder complaints represent the greatest threat in dollars, says attorney Robert Suomala, vice chairman of the American Bar Associations D&O liability committee.
Indeed, a Towers Perrin survey found that the average size of a shareholder D&O liability claim award rose to a record $8.7 million in 1999, while employee claims cost an average of only $306,000. Shareholder claims were the more common among publicly traded companies, while employee claims accounted for most of the activity at privately held firms. Overall, D&O premiums are declining, except in the high-tech and biotech industries, where D&O rates continue to rise.
Companies now pay about $250,000 to $275,000 for $5 million worth of coverage, up from $200,000 a year ago, says a broker at American International Group, a major high-tech insurance carrier. He attributes the increase in premiums to the rise in lawsuits, which typically take about three years to snake through the system, from filing, to judgment, to setting the new policy premium. After the initial $5 million coverage, rates drop about 20 percent for additional $5 million increments.
How much coverage do you require? "As much as you can afford," advises Tony Galban, VP of D&O underwriting at Chubb Executive Risk. The number of securities claims that settled for a cash payment rose almost 40 percent in 2000 to 156 from 112 the previous year, and the total value of those claims more than doubled to $4.47 billion, according to Galban.
Tech companies, whose stocks tend to be extremely volatile, and which often use stock swaps to accomplish mergers and acquisitions, are a favorite target for shareholder suits.
Other insurance experts suggest buying D&O coverage equal to about 5 percent to 10 percent of a companys total market capitalization. In no case, they say, should you have less than $1 million in D&O coverage.
Other considerations in buying D&O insurance include the claims experience of similar companies, the financial health of the insurer and the exclusions in the policy. Situations not usually covered by standard D&O policies include lawsuits brought by one director against another and insider trading allegations.