As a financial professional doling out life and money recommendations, professional liability insurance is an important part of the financial advisors’ back end resource suite. This product can be compared to your homeowners insurance, you may never need it, but if you do, you’ll be very happy that you have it.

What is Professional Liability Insurance?

This specialized insurance protects financial advisors against negligence and other claims alleged by their clients. Also known as errors and omissions (E&O) insurance, this insurance might cover negligence, malpractice or misrepresentation claims. In most cases, financial planners aren’t required to have a professional liability insurance policy, but when you’re practicing with the public, it’s important to be prepared for the unexpected claim which may cause you and your firm potential financial hardship. (For more, see: Property, Casualty and Liability Insurance — Professional and Director Liability.)

So, let’s assume you’ve decided this is an important coverage to obtain; here’s what you need to know about professional liability insurance:

  • Purpose of the coverage
  • Who is covered
  • What services are covered
  • What is excluded from coverage
  • How to practice in accord with the professional liability policy

Why Get It?

Financial planners are at the pulse of their clients lives. If a client loses money, through your fault or not, the consumer may sue you. Mistakes happen, and even when they don’t clients can become unhappy with your services. Financial markets go up and down, and financial losses may spur an unhappy customer to call her lawyer. Lawsuits are time consuming and stressful; the professional liability insurance policy can relieve some of these potential burdens. Successful businesses are prepared for the unexpected, and that's where professional liability insurance comes in. (For more, see: Cover Your Company with Liability Insurance.)

Services and Coverage

The policy will specifically lay out what and who is covered. The policy will likely cover breach of fiduciary duty, lack of regulatory compliance and legal coverage. In general, E&O insurance is structured to cover the professional when the advisor makes a mistake or is accused of malfeasance. Whether the advisor is at legally responsible or not, the insurance will offset the cost of responding to legal claims. (For related reading, see: Asset Protection for the Business Owner.)

If you forget to inform a client of the time frame for a 401(k) rollover when he switches jobs, you may be at fault or liable for his penalties, fees and/or taxes. The E&O policy will serve you well in this type of situation.

You may wonder what would happen if the front end worker, or a consultant, working on behalf of the firm makes a mistake. Comb the insurance policy and understand who is covered. Sometimes, W-2 employees are covered, but not independent contractors. Knowing these small differences in the policy can translate into big bucks when a claim is made. (For more, see: Filling the Gaps in General Liability Insurance.)

What's Excluded From Coverage?

Understand your policy. Is discretionary advice excluded? This is surprise exclusion for many insurance brokers as it is specific to the financial advisory business.

Another potential exclusion may come up if your company is paying bills on behalf of the client. A client asked her advisor to handle bills to the nursing home for her husband’s care. Several years later, she discovers that your company significantly overpaid the nursing home, and she’s not able to recoup the overpayment. Your liability policy may not cover those bill paying services because they fell under the exclusion for discretionary advice.

Review all of the aspects of the professional liability insurance policy with the insurance broker and know what is and isn’t covered. A consent to settle is another clause that the advisor needs to understand. That way the planner avoids surprises when you are compelled to settle a claim instead of fighting it. Make sure the company policies are aligned with the insurance coverage. (For more, see: Insurance Coverage: A Business Necessity.)

The Bottom Line

As with any type of insurance, consult with a trusted insurance agent to find the best policy for your needs. Buy the policy from an agent familiar with the financial advisory business. Make certain you know the coverages and exclusions in the policy. Include coverage for employees as well. Learn about how to file a claim in advance so in the heat of a legal action, you are ready to proceed. Finally, practice in a way that ensures office policies and procedures are aligned with the professional liability insurance. If the advisor understands the professional liability insurance product and claims process then when a claim is filed, he or she has the greatest likelihood of a successful resolution. (For more, see: Start Your Own Financial Planning Firm and Top Tools Every Financial Advisor Needs.)

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.