Professional Indemnity Insurance - Protecting the business
I was recently asked to review a Professional Indemnity claim that had been denied by the insurer. A lawyer had looked at the wording of the policy and had described the cover as a ‘Clayton’s Cover’. For those who cannot remember the advertisement from the 1960s to 1980s advertising non-alcoholic spirits, Claytons was the drink you had when you were ‘not having a drink’.
In this case the Insured operated one company that designed and manufactured electrical componentary. A claim arose due a failure in design.
At the request of the broker, I perused the documents along with one of the team from LMI, Max Salveson, and I now reproduce our comments to the broker below. As the matter is yet to be resolved, I have not provided copies of any documents nor do I list any of the parties involved as this would be unprofessional. Having said this, the issues are real and warrant discussion.
The comments and points raised were as follows:
1) Organisations that employ specialist professionals in Engineering and IT work are often required to have Professional Indemnity (“PI”) insurance, or seek it in any case, on the recommendation of their broker because the standard professional exclusion in most Broadform Policies using the term ‘not for a fee’ is now being interpreted and applied more stringently by insurers. (On questioning several ‘Old School’ underwriters, they all advise that this new stringent approach was not the intention of the drafters of the exclusion.)
2) Some PI insurers regard a manufacturing development charge associated with product development as a fee, will scrutinise the make up of invoices for evidence of any additional charges, and, if found, will reject a Broadform liability claim.
3) The standard Professional Indemnity policy was originally designed for consulting professionals where an act, error or omission will see them fully responsible to their clients for damages arising from any error or omission in their professional work.
4) Professionals do not manufacture. They provide the prescription, plan or design that others engaged in manufacturing, building or whatever follow. It is customary for PI insurers to incorporate a manufacturing and sale of goods exclusion in their PI policies.
5) ‘Damages’ claimable against the professional consultant by any client will include all loss relating to property and bodily injury including the client’s costs in recalling products etc.
6) That all sounds straight forward.
7) These days all firms employ in-house professionals, not only in specialist areas where qualifications are required to check processes and quality but also in relation to product development. These firms work in partnership with their customers and may also use the services now provided by many universities to industry and commerce.
8) For some time, insurers appeared to be accepting of the fact that the term ‘not for a fee’ in Broadform Liability Policies meant that the professional exclusion did not apply to negligence associated with the work of in-house professionals.
9) However, great care is now needed because of the matters raised in 1) and 2) above.
10) The information contained on the this paricular matter’s Policy Schedule indicates that the business of the firm is “Advice, design & specification in respect of Electrometric Applications” and the insurance was being predicated to cover the risk of the business in relation to its professional services.
11) We take the description of the business to mean that the Insured not only operated a consultancy business in their particular speciality but that they also designed, manufactured and/or installed equipment and that the claim which has arisen is either in respect of their advice or their products meaning either equipment sold or constructed by them on site.
12) Where the business carries on these activities as a part of the same business entity, some important decisions are required and it is desirable that the PI and Broadform Policies are placed with the same insurer to avoid gaps in wordings.
13) To the best of our knowledge, all PI policies have a manufacturing exclusion as PI insurers say their policies are not a substitute for products liability insurance.
14) Similarly, many non-PI insurers say they do not want to cover Professional Risks relating to the design and specification of products.
15) Particular underwriting skills need to be applied to ensure that the Professional Indemnity policy is properly worded when covering professional activities that are part of the business of a single entity.
16) A quick solution to all of this that we have suggested in the past, where providing advice to brokers and their clients, is to recommend the client that they establish a separate legal entity in which all professional services are conducted.
17) Such separate entity will charge clients directly for their professional services and manufacturing costs will be billed to clients by the operating entity.
18) On the evidence of the documents the general purpose of the policy was to ensure that any claims for errors and omissions in the professional work of the business was to be covered.
19) Exclusion 7.18 refers to the “sale and supply of any good”. Good is not defined and whether the services or work provided is within the legal definition of ‘Good’ is something for legal advisors and/or a court to determine based on the contract wording and the application of Australian Law.
20) Exclusion 7.18 has a write back in respect of “claims arising directly from the cost of correcting any act or error in design”, but this will not include the costs associated with product guarantee or recall.
21) Exclusion 7.18 appears to be directed at:
a) Excluding claims for product liability;
b) Including coverage for the costs incurred in correcting faulty design. These costs would be excluded under a Broadform Policy and the Material Damage and Liability Sections of a Contract Works Policy. The material damage section of a contract works policy would normally pick up costs associated with subsequent damage arising from faulty design or workmanship.
22) The insurer has added a number of endorsements and the intention of these needs to be explored.
23) The Construction Exclusion deletes coverage for construction etc. and Supervision but then has a write back that says “unless such supervision is conducted as a specifically contracted construction manager, project manager, engineer etc.”. Does the write back for supervision then apply to the first part in relation to construction? This is where the claims will come from if the supervision is defective. It is important to know how this clause was explained to the broker. The question arises as to whether this particular Insured was contracted to provide supervision.
24) The Faulty Manufacturing Exclusion is clearly aimed at mistakes in the actual manufacturing process at operator level, which would be covered as a Broadform Liability risk.
25) The Specific Activities Exclusion is of great interest. Added as an endorsement, it therefore takes precedence over the standard wording. This endorsement appears to be reinforcing the fact that regardless of anything else, the intention of the policy was to “Indemnify the Insured for all claims for which they became legally liable to pay for any civil liability incurred in the conduct of the business as described in the Schedule”. In the matter under review, this was described as: “Advice. Design and/or specification in respect of elastometric (Electrometric – probably a typo) applications or devices”.
26) An insurance policy is subject to the Principle of ‘Utmost Good Faith’, which is enshrined in the Insurance Contracts Act 1984. This principle applies both to the Insured and the insurer and regardless of the interpretations now being placed on the wording by other parties, whether in Australia or London, the important issue is how the insurer’s underwriter explained the operation of the policy as being fit for the purpose of insuring the risk of the Insured’s professional risk to the broker as the insured’s representative.
27) Until this matter is resolved, it will reflect adversely on the reputation of the insurer to be able to offer appropriate professional indemnity coverage to companies operating under a single entity.
I hope the overview of this case points out the pitfalls that can arise where the cover for PI is not with the same insurer and/or closely reviewed against the Broadform liability coverage.
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