Liability Insurance

What is 'Liability Insurance'

Liability insurance is any insurance policy that protects an individual or business from the risk that they may be sued and held legally liable for something such as malpractice, injury or negligence. 

Liability insurance policies cover both legal costs and any legal payouts for which the insured would be responsible if found legally liable. Intentional damage and contractual liabilities are typically not covered in these types of policies.

BREAKING DOWN 'Liability Insurance'

Liability insurance is critical for those who may be held legally liable for the injuries of others, especially medical practitioners and business owners. A product manufacturer may purchase product liability insurance to cover them if a product is faulty and causes damage to the purchasers or any other third party. Business owners may purchase liability insurance that covers them if an employee is injured during business operations.

Various Types of Liability Insurance

Business owners are exposed to a range of liabilities, any of which can subject their assets to substantial claims. All business owners need to have in place an asset protection plan built around available liability insurance coverage. Here are the main types of liability insurance:

Employer’s liability and workers' compensation is a type of mandatory coverage for employers, which protects the business against liabilities arising from injuries or the death of an employee.

Product liability insurance is for businesses that manufacture products for sale on the general market. Product liability insurance protects against lawsuits arising from injury or death caused by their products.

Indemnity insurance provides coverage to protect a business against negligence claims due to financial harm resulting from mistakes or failure to perform.

Director and officer liability coverage is for a business that has a board of directors or officers, with the insurance covering them against liability if the company is sued. While a corporation by definition offers some amount of personal protection against liability to employees and directors, some companies choose to provide additional protection to those key members of the executive team.

An umbrella liability policy is a personal liability policy designed to protect against catastrophic losses. Generally, umbrella liability coverage kicks in when the liability limits of other insurance are reached.

Commercial liability insurance is a standard commercial general liability policy (also known as comprehensive general liability insurance) that provides insurance coverage for lawsuits arising from injury to employees and public, property damage caused by an employee and injuries suffered by the negligent action of employees. The policy may also cover infringement on intellectual property, slander, libel, contractual liability, tenant liability and employment practices liability.

The comprehensive general liability (CGL) policy is tailor-made for any small or large business, partnership or joint venture businesses, a corporation or association, an organization, or even a newly acquired business. Insurance coverage in a CGL policy includes bodily injury, property damage, personal and advertising injury, medical payments, and premises and operations liability. In the case of lawsuits, insurers provide coverage for compensatory and general damages; punitive damages are generally not covered under the policy, although they may be covered if they are permitted by the jurisdiction of the state in which the policy was issued. The amount of risk associated with the business and the size of the business determines the total coverage.

The policy provides compensation for defending or investigating a lawsuit; court costs including attorneys' fees, police report costs and witness fees, any judgment or settlement resulting from the lawsuit, medical expenses for the injured persons, etc. Here, insurers retain the right to defend any suit against the insured company arising from bodily or property damages. 

Closing the Gaps in General Liability Insurance

Commercial general liability insurance protects against most legal hassles, but it won't protect directors and officers from being sued or protect against errors and omissions. For these special cases, you need specialized policies. Below, are lesser-known liability insurance policies that are worth considering for your professional coverage needs.

Errors & Omissions (E&O) Liability Insurance

  • What it covers: Errors & Omissions policies offer insurance coverage for lawsuits arising from rendering negligent professional services or failing to perform professional duties. Lawyers, accountants, architects, engineers, or any business providing a service to a client for a fee should purchase this form of insurance.

  • Coverage: Usually, the coverage includes legal, judgment and settlement expenses up to the limit of the policy. Coverage is offered as per the risk exposures of the insured, as some professionals have more potential exposure than others. Coverage typically starts at $1 million and may have a deductible of $1,000 to $25,000 per claim.

  • Exclusions: Common exclusions include claims arising from criminal, fraudulent or dishonest acts, bodily injury or property damage, employment-related claims and punitive damages.

  • Other considerations: Factors influencing insurance cost include location, class of business and claims experience of the individual and the industry. These policies are offered on a claims-made basis, in which claims must be made and reported during the policy period. E&O policies have a retroactive date wherein the insurer will not cover claims arising out of acts committed before the retroactive date. Retroactive coverage is available but comes with higher premiums. Most claims-made policies allow individuals to buy "tail coverage." This extended reporting period covers claims made after you discontinue your professional liability coverage, often because of retirement. The main purpose of tail coverage is to protect the individual from claims that occurred during their active professional, practice but were only reported after they retire or quit practicing. If an E&O policy is canceled and the extended reporting period coverage is not bought, then the entire coverage stops. In many cases, depending upon the policy terms, the insurer may have a duty to defend the entire claim, even if it includes non-covered allegations against the insured. However, the insurer is not obligated to identify the insured for a settlement, verdict or judgment based upon non-covered allegations—just to continue in the overall providing of legal defense.

Directors & Officers (D&O) Liability Insurance

  • What it covers: The policy provides protection to directors and officers of large companies against legal judgments and costs arising from unlawful acts, erroneous investment decisions, failure to maintain the property, releasing confidential information, hiring and firing decisions, conflicts of interest, gross negligence and various other errors.

  • Coverage: There are three main types of directors and officers liability coverage: Coverage A, B, and C (detailed below). The minimum policy limits of liability are $1 million or even $5 million, which is used for defense expenses, expenses of a claim and damages, judgments and settlements expenses. The $1 million limit is per policy and is not shared among individual policies.

  • Exclusions: Most D&O policies will exclude coverage for fraud or other criminal acts. A compromise is the "segregate clause" in many D&O policies, which provides coverage for the company and other innocent parties that might be dragged into a lawsuit due to criminal actions of another company director. Other typical exclusions are coverage for claims arising out of prior acts, punitive damages, and bodily injury or property damage. However, punitive damages may be covered as per the jurisdiction of the state in which the policy was issued.

Coverage A: This is a personal/employee coverage that covers past, present, and future directors and officers to help them defend themselves against claims alleging a wrongful act and the personal liabilities they encounter for their acts. A company may not be able to indemnify its D&Os directly because either it is not permitted by law, or by company bylaws.

Coverage B: This is corporate coverage for the company to the extent that it can or may be permitted to indemnify its directors and officers for claims against them; however, the company is not covered for its own liability. Therefore, during a claim the company receives the compensation; in turn, the company then reimburses the amounts to directors and officers.

Coverage C: This is entity coverage wherein the company is insured against securities claims. Lawsuits naming directors and officers along with other parties are common. The coverage provides protection to the company for its own liabilities in such a situation. Entity coverage basically renders allocation (the portioning off of blame) unnecessary for securities claims. Additionally, D&O policies may be composed of extensive allocation clauses that force the parties to negotiate an allocation agreement. In case both parties are unable to reach an agreement, the policy may provide a default or force the parties to accept arbitration.

Other Considerations: Factors such as the size and form of the company, location, mergers and acquisitions, industry type and loss experience determine the premium rates in a typical D&O policy. It is important to note that the insurer does not have the duty to defend the directors and officers. Many insurers allow deductibles if they can identify the individuals named in the legal suit. D&O policies are offered on a claims-made basis; in other words, claims must be made and reported during the policy period. Though, the insurer holds the right to oversee the defense and approval of defending strategies, expenditures, and settlements.

Many insurers also include employment practices liability coverage in the D&O policy. The coverage may not be as comprehensive as a traditional stand-alone policy and may offer relatively less coverage.

Nevertheless, certain types of companies are protected under safe harbor statutes. For example, some states have provisions that protect directors of non-profit companies from losses. But safe harbor statutes do not reduce the necessity for insurance—the provisions only protect the individual from a final adjudication but not from a suit being filed.

When Does it Make Sense to Buy Personal Liability Insurance?

Personal liability insurance policies are purchased primarily by high-net-worth individuals or those with sizable assets, but this type of coverage is recommended to anyone with a net worth that exceeds the combined coverage limits of other personal insurance policies, such as home and auto coverage.

In short, personal liability insurance makes sense for individuals who have a higher-than-average risk of being sued, such as landlords.

Homeowners insurance covers liability claims from accidents that occur on a policyholder's property, but only to a specified limit. Homeowners facing fees beyond that amount could face financial disaster.

Commonly called an umbrella insurance policy, personal liability insurance makes payments on the policyholder's behalf in cases of property and auto accidents, as well as situations that involve libel, slander, vandalism or invasion of privacy. The policy also covers injuries that occur at secondary residences or seasonal homes, within recreational vehicles, on the premises of rental properties, or on a boat or watercraft owned by the policyholder.

The cost of an additional insurance policy doesn't appeal to everyone, although most carriers offer reduced rates for bundled coverage packages. Personal liability insurance is considered a secondary policy and may require policyholders to carry certain limits on their home and auto policies, which may result in additional expenses.