Professional Indemnity insurance explained

Professional Indemnity insurance is a form of liability insurance that provides cover for the financial consequences of professional negligence, following a breach of professional duty by way of neglect, error or omission.

In addition, an indemnity is provided in respect of the legal and other costs and expenses incurred in the defence of any claim. The general philosophy in the litigious world that we now live in tends to be 'if something goes wrong, somebody must be to blame, and that somebody has to pay'.

A professional cannot ignore an allegation of professional negligence. The allegation must be defended or admitted, and as a result, there will be cost implications in either case. Professional Indemnity insurance provides the ultimate safety net when all else fails. However, like any other safety net, its use should be avoided as much as possible.

Any professional person providing advice, design, specifications, supervision etc, whether this be for a fee or gratuitously, owes a duty of care to their client, and third parties.

The duty of care owed is generally the exercise of 'reasonable skill and care', in the discharge of the services provided. If a professional fails to exercise this duty (i.e. is negligent) they may be liable for losses incurred by their client, and/or third parties. Taking into account the operation of the current legal system, even proving innocence can be very costly.

A professional purchases Professional Indemnity insurance for their own protection. The cover is not for the benefit of the professional's client, although far too often, it is not seen that way. Clients cannot claim directly against the Professional Indemnity cover carried by the professionals - they must prove liability first, a process which can be time-consuming, expensive and uncertain.

Personal liability attaches where a practice operates as either a sole proprietor or a partnership. In the case of a partnership, liability is joint and several. Even when a practice ceases to operate, these personal liabilities do not come to an end, but continue for the limitation periods in contract and tort.

In the case of a director of a limited company, legal opinion suggests that whilst all corporate liability ceases when the company no longer exists as a legal entity, each director is liable for his own work. Therefore, if a limited company ceases to trade, it does not preclude legal proceedings being brought against individual directors.

First, any potential plaintiff must prove negligence on the professional's behalf, (i.e. a failure to exercise reasonable skill and care in the discharge of its services).

A claim can be brought in contract or tort. It is often more difficult to succeed in a claim in tort as the following tests must be satisfied:

- the plaintiff must prove that the professional owed him a duty of care

- the plaintiff must prove that the professional has breached that duty

- the plaintiff has suffered financial loss as a direct result of that breach

If an allegation of negligence is upheld the professional is likely to be liable for the losses incurred by the plaintiff which arise as a reasonably foreseeable consequence of the professional's actions. The professional will often be responsible for the plaintiff's legal costs and these can be substantial. It is often the case that large sums of money are spent simply trying to recover fairly minor losses.

Direct financial losses (economic and consequential loss) as opposed to the cost of rectifying a defect is implicit under contract unless specifically excluded. There is more of a grey area arising out of the question of liability for economic and consequential loss at common law (i.e. in tort) although recent judgements have allowed such losses to be recovered.

Professional Indemnity insurance provides only limited cover against the consequences of claims for professional negligence. Unless contractual limitations have been agreed between the professional and his client, the professional's liability:

- is unlimited in amount; and

- extends over a considerable period of time

Professional Indemnity insurance, by contrast:

- will have a set limit on the amount that insurers will pay - the limit of indemnity

- operates for a set period of time - the period of insurance

- is subject to the policy terms, conditions, limitations and exclusions.

Professional Indemnity insurance operates on what is known as a 'claims made' basis. This means that it is the policy in force at the time the claim is notified which will operate, irrespective of when the work was actually undertaken or when the alleged act of negligence took place.

The ability of clients or third parties to bring claims many years after services are complete (subject to the relevant limitation periods) emphasises the importance of maintaining cover into the future.

The limit of indemnity is the maximum amount that can be claimed from insurers for the professional's liability to pay claimant damages. Defence costs are usually paid in addition to the limit of indemnity.

Disclosing the limit of indemnity to a client does not lead to a limitation of liability, which can only be achieved by negotiating a specific financial cap as part of the professional's appointment.

The limit of indemnity operates in one of two ways:

Each and every claim cover - this means that the indemnity limit applies separately to each claim that is made under the policy. However, all claims arising from the same occurrence would be regarded by insurers as one claim.

Aggregate cover - the limit of indemnity would apply as one single amount for all claims made in each period of insurance.

Policies operating on an 'each and every' basis, would still normally apply in respect of:

- pollution/contamination claims

- claims brought in American or Canadian courts